Belfer Center for Science & International Affairs

Sustainability Information and Pension Fund Investment

Bernd Kasemir and Andrea Süess

2002-13

September 2002

Global Environmental Assessment Project Environment and Natural Resources Program

CITATION, CONTEXT, AND P ROJECT ACKNOWLEDGEMENTS This paper may be cited as: Kasemir, Bernd, and Andrea Süess. 2002. “Sustainability Information and Pension Fund Investment.” Belfer Center for Science and International Affairs (BCSIA) Discussion Paper 2002-13. Cambridge, MA: Environment and Natural Resources Program, Kennedy School of Government, Harvard University. It is available at http://environment.harvard.edu/gea. No further citation is allowed without permission of the authors. Comments are welcome and may be directed to Bernd Kasemir at the Belfer Center for Science and International Affairs, John F. Kennedy School of Government, Harvard University, 79 John F. Kennedy Street, Cambridge, MA 02138, e-mail [email protected]. The Global Environmental Assessment Project is a collaborative team study of global environmental assessment as a link between science and policy. The Team is based at Harvard University. The project has two principal objectives. The first is to develop a more realistic and synoptic model of the actual relationships among science, assessment, and management in social responses to global change, and to use that model to understand, critique, and improve current practice of assessment as a bridge between science and policy making. The second is to elucidate a strategy of adaptive assessment and policy for global environmental problems, along with the methods and institutions to implement such a strategy in the real world. The Global Environmental Assessment (GEA) Project is supported by a core grant from the National Science Foundation (Award No. BCS-9521910) for the “Global Environmental Assessment Team.” Supplemental support to the GEA Team is provided by the National Oceanic and Atmospheric Administration, the Department of Energy, the National Aeronautics and Space Administration, the National Science Foundation, and the National Institute for Global Environmental Change. Additional support has been provided by the Department of Energy (Award No. DE-FG02-95ER62122) for the project, “Assessment Strategies for Global Environmental Change,” the National Institute for Global Environmental Change (Awards No. 901214-HAR, LWT 62-123-06518) for the project “Towards Useful Integrated Assessments,” the Center for Integrated Study of the Human Dimensions of Global Change at Carnegie Mellon University (NSF Award No. SBR-9521914) for the project “The Use of Global Environmental Assessments,” the Belfer Center for Science and International Affairs at Harvard University’s Kennedy School of Government, the International Human Dimensions Programme on Global Environmental Change, Harvard’s Weatherhead Center for International Affairs, Harvard’s Environmental Information Center, the International Institute for Applied Systems Analysis, The Center for International Earth Science Information Network, the German Academic Exchange Service, the Heinrich Boll Foundation in Germany, the Heinz Family Foundation, the Heinz Center for Science, Economics and the Environment, the Massachusetts Institute of Technology’s Center for Environmental Initiatives, a National Science Foundation Career Grant to Professor Daniel Schrag, the National Center for Environmental Decisionmaking Research, Yale’s Department of Forestry and Environmental Studies, the University of Amsterdam’s Department of Science Dynamics, the University of California at Irvine’s School of Social Ecology, the University of California at Santa Cruz’ Institute for Global Conflict and Cooperation, and the World Health Organization’s Global Forum for Health Research. The views expressed in this paper are those of the author and do not imply endorsement by any of the supporting institutions. Publication abstracts of the GEA Project can be found on the GEA web site at http://environment.harvard.edu/gea. Further information on the Global Environmental Assessment Project can be obtained from the Project Associate Director, Nancy Dickson, Belfer Center for Science and International Affairs, John F. Kennedy School of Government, Harvard University, 79 John F. Kennedy Street, Cambridge, MA 02138, telephone (617) 496-9469, telefax (617) 495-8963, e-mail [email protected].

F OREWORD This paper was written as part of the Global Environmental Assessment Project, a collaborative, interdisciplinary effort to explore how assessment activities can better link scientific understanding with effective action on issues arising in the context of global environmental change. The Project seeks to understand the special problems, challenges and opportunities that arise in efforts to develop common scientific assessments that are relevant and credible across multiple national circumstances and political cultures. It takes a long-term perspective focused on the interactions of science, assessment and management over periods of a decade or more, rather than concentrating on specific studies or negotiating sessions. Global environmental change is viewed broadly to include not only climate and other atmospheric issues, but also transboundary movements of organisms and chemical toxins. (To learn more about the GEA Project visit the web site at http://environment.harvard.edu/gea/.) The Project seeks to achieve progress towards three goals: deepening the critical understanding of the relationships among research, assessment and management in the global environmental arena; enhancing the communication among scholars and practitioners of global environmental assessments; and illuminating the contemporary choices facing the designers of global environmental assessments. It pursues these goals through a three-pronged strategy of competitively awarded fellowships that bring advanced doctoral and post-doctoral students to Harvard; an interdisciplinary training and research program involving faculty and fellows; and annual meetings bringing together scholars and practitioners of assessment. The core of the Project is its Research Fellows. Fellows spend the year working with one another and project faculty as a Research Group exploring histories, processes and effects of global environmental assessment. These papers look across a range of particular assessments to examine variation and changes in what has been assessed, explore assessment as a part of a broader pattern of communication, and focus on the dynamics of assessment. The contributions these papers provide has been fundamental to the development of the GEA venture. I look forward to seeing revised versions published in appropriate journals and books. William C. Clark Harvey Brooks Professor of International Science, Policy and Human Development Director, Global Environmental Assessment Project John F. Kennedy School of Government Harvard University

ABSTRACT The present study targets a specific actor group in the issue domain of sustainable development. That is representatives of the financial industry, particularly those managing the increasing amount of pension resources that are accumulated in developed economies. By setting this focus, this study complements other research in the Global Environmental Assessment Project at Harvard’s Kennedy School, which focuses mainly on the use of global change and sustainability assessments in public policy. Without being the topic of much public debate, pension funds control a significant part of the economies in many developed countries by their stock holdings. In principle, they are an essential institution for making large corporations accountable to the public, whose pension resources are invested in these corporations. By definition, pension funds have to take a long view with regard to investment strategies. This opens the possibility for them to become major advocates for sustainability strategies in the private sector. Indeed, sustainability criteria are already integrated to some extent in many asset management policies of pension funds, and it can be expected that sustainable asset management is a high growth industry. The present work studies current practices of integrating sustainability aspects into the management of pension resources, and aims to understand the mindsets and expectations of professionals active in this field. Understanding better their framing of the issue and their expectations for future developments is essential in getting a grip on trends in this part of the investment industry. In order to study the influence of different cultural traditions, market conditions, and histories in the field of responsible investment, interviews were conducted with investment professionals on both sides of the Atlantic. Strategie s employed by pension fund managers in integrating sustainability aspects into asset management can be distinguished into the two approaches of ‘selective investment’ and ‘engagement.’ Strategies by external investment experts working on contracts for pension funds can be differentiated according to the additional dimension of ‘standardized’ versus ‘customized’ products and services. In these different activities, actors in the investment field use sustainability information and assessments in different form and from different sources. We found that currently, mainly assessments produced by commercial service providers are used. While academic researchers are sometimes used as personal points of reference, assessments generated by academic sustainability science are of very limited use to investment actors. We study reasons for this, mainly connected to transparency and saliency of academic sustainability assessments, and discuss how this situation could be improved. This GEA working paper presents parts of the empirical material we collected in this study. A more concise and systematic analysis of our findings has been published as B. Kasemir, A. Süess, and A.J.B. Zehnder. 2001. “The Next Unseen Revolution – Pension Fund Investment and Sustainability.” Environment 43(9): 8-19.

AUTHORS’ ACKNOWLEDGEMENTS The authors are deeply indebted to the pension fund managers and external investment experts who shared their experiences in interviews and questionnaire responses. The following of them have agreed to be named explicitly in this acknowledgment: Abna Agyeman (Norwich Union Sustainable Future Funds CGNU Life Assurance Ltd.), Philip Ayton (Pavilion Asset Management Ltd.), Rod Balkwill & Judith Lowes (Co-operators Investment Counselling Ltd.), Richard Beaulieu (Gestion de portefeuille Natcan), Erol Bilecen (Bank Sarasin & Cie), Gianni Bottegal & Felix Pfeifer (NEST Sammelstiftung), Paul Burke (Co-operative Insurance Society), Bill Chinery (Barclays Global Investors), Lynn A. Clark (Ontario Muicipal Employees Retirement System), Mary Cotrill (CalPERS), Breda Cummins (Robeco), Alan Daxner (McLean Budden Ltd.), Antoine Dehen (ABF Capital Management), Linda Descano (Salomon Smith Barney Inc.), Nico Dijkhuizen (Pensioenfonds Productschappen), Patrick W. Doherty (New York City Comptroller’s Office), Peter Dunscombe (BBC Pension Scheme), Michelle Edkins (Hermes Investment Management), Eugene Ellmen (Social Investment Organisation Canada), Jandaan Felderhoff (Lombard Odier Asset Management (Nederland) N.V.), Richard La Flamme (Desjardins Pension Fund), Georg Furger (Credit Suisse Asset Management), Philippe Gabelier (La caisse de dépôt et placement du Québec), Bernard Gaillard (Caisse de prévoyance du personnel des Etablissements Publics médicaux du Cantone de Genève), James Giuseppi (Henderson Global Investors), Daniel Gloor (Beamtenversicherungskasse des Kantons Zürich), Sharlyn Graham (Laketon Investment Management Ltd.), Paul Grise (Hospitals of Ontario Pension Plan System), Jacques Grubben (Insinger de Beaufort), Elaine Hamilton (Pension Fund, The United Church of Canada), Colin Hay (Lothian Pension Fund City of Edinburgh Council), Karl Herzog (Julius Baer Asset Management Ltd.), Bozena Jankowska (Dresdner RCM Global Investors (UK) Ltd.), Tamara Jensen (Roxbury Capital Management), David Knight (Knight, Bain, Seath and Holbrook Capital Management), Ivo Knöpfel (SAM Sustainability Group), Laurie Lawson (University of Toronto), André Ludin (NOVARTIS Pension Fund), Colin Melvin (Baillie Gifford & Co.), David Moran (Dow Jones Index), Louis Morisette (SNEGQ), Werner Nussbaum (ISP Innovation Second Pillar), John Owens (Aberdeen Asset Managers Ltd.), Geof Pearson (Sainsbury’s Pension Scheme), Anna Pot (ING Investment Management), Robert Preston (AXA Investment Managers), Caroline Schum (ethos, Swiss Investment Foundation for Sustainable Development), Inge Schumacher (UBS), Alexander Schwedeler (Triodos Bank NV), Felix Senn (Pensionskasse des Bundes), Karen Shoffner (Castellum Capital Management Inc.), David Somers (David Somers Clerical Medical Investment Management), Jason Stefanelli (State Street Global Advisors Ltd.), Raj Thamotheram (Universities Superannuation Scheme), David Unitt (FTI - Banque Fiduciary Trust SA), Sylvia van Waveren-Severs (PGGM Zeist), Paolo Wegmüller (Freie Gemeinschaftsbank BCL), Neville White (CCLA Investment Management Ltd.), Thierry WiedemannGoiran (Macif Gestion), Ton Zimmerman (Nedlloyd Pension Fund). The authors are also very grateful to William Clark, Nancy Dickson, Hadi Dowlatabadi, Ottmar Edenhofer, Matthew Gardner, Jill Jäger, Carlo Jaeger, Sheila Jasanoff, Don Kennedy, Stephan Lienin, Pam Matson, Steve Rayner, Jan Rotmans, Richard Sandor, Marjolein van Asselt and Alexander Wokaun for valuable discussions. This article is based on research supported in part by grants from the European Commission (contract ENV4-CT97-0462), the Swiss Federal Office for Education and Science (contract BBW-97.0425), and from the National Science Foundation (Award No. SBR-9521910 for the “Global Environmental Assessment Team”). The authors also want to acknowledge support from the Belfer Center for Science and International Affairs at Harvard University’s Kennedy School of Government.

TABLE OF CONTENTS 1

INTRODUCTION ..................................................................................................................1

2

RESEARCH QUESTIONS AND STUDY DESIGN ...........................................................2

3

PERSPECTIVES OF PENSION FUND REPRESENTATIVES ......................................4

3.1

Why do pension fund managers take sustainability into account?....................................................................4

3.1.1 3.1.2 3.1.3 3.2

Long-term and short-term investment goals............................................................................................................4 Rationales for taking sustainability into account....................................................................................................6 Whose decision?.........................................................................................................................................................10 Two approaches to integrating sustainability concerns into pension management ................................... 11

3.2.1 3.2.2 3.2.3 3.2.4 3.3

Selective Investment..................................................................................................................................................11 Engagement.................................................................................................................................................................13 How could these two approaches develop in the future?....................................................................................15 Transparency...............................................................................................................................................................17 The use of sustainability information ..................................................................................................................... 19

3.3.1 3.3.2 3.3.3 3.3.4

‘Standard of proof’ of sustainability information needed...................................................................................19 Current sources of information................................................................................................................................20 Legitimacy and credibility of sustainability information ....................................................................................21 Using academic sustainability assessments in the future? Saliency and transparency..................................23

4 PERSPECTIVES OF EXTERNAL ASSET MANAGERS AND SUSTAINABILITY INVESTMENT CONSULTANTS ..............................................................................................26 4.1

Why do investment experts take sustainability into account? ......................................................................... 27

4.1.1 4.1.2 4.2

Long-term and short-term investment goals..........................................................................................................27 Rationales for taking sustainability into account..................................................................................................28 Different approaches and tools for taking sustainability into account .......................................................... 31

4.2.1 4.2.2 4.3

Standardized vs. customized products....................................................................................................................31 Selective investment vs. engagement .....................................................................................................................34 The use of sustainability information ..................................................................................................................... 35

4.3.1 4.3.2 4.3.3

Current sources of information................................................................................................................................35 Quality and credibility of current sustainability information .............................................................................36 Using academic sustainability assessments in the future? Saliency and transparency..................................37

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SUMMARY AND CONCLUSIONS...................................................................................40

6

REFERENCES .....................................................................................................................43

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ENDNOTES ..........................................................................................................................45

1 INTRODUCTION Today’s environmental problems are more complex and more interdependent that the individual problems tackle d in the last decades, like acid rain in Europe or global ozone depletion. Rather, many current individual environmental and social issues are better viewed as multiple dimensions of a common problem. This is how to achieve ‘sustainable development,’ where each generation manages to meet its needs while restoring and nurturing the planet’s life support system (Clark 2001). Managing the transition towards sustainable development is an intricate process of social learning. In this unprecedented journey towards sustainability, we have to rely on incomplete information that evolves as we progress with our expedition. Feedbacks are essential in steering this course (National Research Council 1999). Sustainability science aims to give such feedbacks to society, by assessing in which areas we are or are not making progress towards sustainability. In order for such assessments to be effective, it is important for sustainability researchers to keep in mind that modern societies don’t have any single central decisionmaker, who would need a single type of sustainability information. Rather, decisions in today’s societies are increasingly taken in informal networks of actors (Fukuyama 1999), while governments are facilitating rather than deciding debates between them (Beck 1994). These actors include NGOs, ordinary citizens, labor unions, business councils and individual companies. Different forms of sustainability information are needed to meet the needs of these different actors. One important group of these actors is decision makers in the private sector. Business can play an enormously positive role in promoting sustainable development (Annan 2000), but can also block effective action in cases where business views have not sufficiently been taken into account (Levy and Newell 2000). Within the business community, there are increasingly voices that support private sector engagement for sustainable development. As Anita Roddick, founder of The Body Shop International puts it, ‘we can’t afford for business to so limit its ambition [to the economic bottom line] when it is faster, wealthier and more creative than governments. There is a new responsibility that we in business must face up to’ (Roddick 2000). This may be seen as contradicting the traditional view that ‘the business of business is business.’ But whose business is it? In a very simplified characterization (neglecting the role of labor unions and other stakeholders), a business is controlled by a group of owners and aims to serve a group of customers. The role of consumers in debates on sustainable development has been discussed widely, and NGOs have been very active in taking on the role of consumers’ advocates. The side of the owners or shareholders of business, however, has been less often discussed in relation to sustainable development. But to a large extent, the owners of business are all of society, at least in developed economies. As Peter Drucker observed already a quarter of a century ago in his provokative book The Unseen Revolution – How pension fund socialism came to America, employees through their pension funds hold a controlling stake in nearly all major companies on the stock market (Drucker 1976). Pension fund investment is thus a major mechanism to make business accountable to society at large, and has a high potential for putting sustainable development on the agenda of the private sector. Indeed, social and environmental issues are already taken into account to a surprising degree in the management of pension assets, and this trend is expected to increase over time. The study discussed in this paper focuses on why sustainability criteria are used in pension fund management, which different tools are applied for this, and how assessments by sustainability scientists could support this development.

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Concerning rationales and tools, differences and similarities between the U.S. tradition of ‘socially responsible investment’ and the new European trend towards ‘sustainability investment’ are discussed. And the hypothesis is studied that current assessments in sustainability science are of limited value for the investment community. It is argued that changes in the design of such assessments as to framing and saliency for investors would be needed to improve this situation.

2 RESEARCH QUESTIONS AND STUDY DESIGN This study addresses several questions relevant to understanding, encouraging, and strengthening the recent trend of pension funds beginning to take an active role in putting sustainability onto corporate agendas. • • •

What motivates pension funds to consider sustainability in managing their assets, and which tools do they use for this? How do U.S. and European approaches and experiences with these investment strategies compare? How can sustainability science help to guide pension investors and corporations?

The conclusions drawn rely on information obtained through interviews and questionnaire responses from representatives of pension funds with collective assets exceeding $600 billion (U.S. dollars), and from external investment consultants who work with these funds to help include sustainability criteria in asset management. Questions explored in our interview on both sides of the Atlantic concerned the following major points: 1) How do you see the relationship between your mandate and sustainability issues? How do you coordinate short- and long-term strategies, and are there major changes in investment patterns if sustainability is taken into account? Is transparency relevant (e.g., UK rules for declaring policies on social and environmental investment)? 2) What types of sustainability information are relevant for your day-to-day decisions (company information, sector information, sustainability portfolios, sustainability indices)? How important are its scientific credibility, and the legitimacy of the people producing this information, for yourself and your clients? 3) How will you decide what sustainability information (and tools to use this information) you’ll need in the future? What will be important regarding quality and transparency of this future sustainability information? In the case that corporations would be routinely requested to give sustainability information as part of their risk disclosure requirements, what would this mean for your business? The study explores sustainability issues in pension fund investment both in the context of ‘active’ investment, where managers choose changing portfolios of companies to invest in, and ‘passive’ investment, based on mirroring specific stock-indices. Attention is given to similarities and differences between the situation in North America and in Europe. In order to capture views of investment professionals on both sides of the Atlantic, interviews are conducted with pension fund managers and external investment experts in eight research regions (see Table 1).

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Table 1: Research regions in Europe and North America

Europe

North America

UK Netherlands Switzerland France

North-Eastern U.S. California Ontario Quebec

The rationale for selecting the European regions is that the UK, the Netherlands and Switzerland (in this order) hold the highest pension fund assets within Europe, while France is an interesting case on the other extreme in that there is practically no private ‘second pillar’ pension system there. The two U.S. research regions were selected because of the possible role of cultural differences between the Northeast and California in the U.S. The same applies to the two different regions selected in Canada, Ontario and Quebec. Pension funds targeted include funds managing pension resources for private sector employees, as well as for public sector employees. Interviews were conducted with pension fund managers and external investment experts rather progressive on this issue, in order to study not only current practices but also possible trends for the future. These interviews were about one hour each, and focused on qualitative issues. The interview methodology chosen was a combination of semi-structured and narrative interview techniques. Interview techniques and expert elicitation have been used as methods for research data collection for at least one century (Converse 1987). Early adaptations of interview methodologies were mainly based on non-structured interview techniques, typically in the field of psychology. Later, structured interviews were conducted in the field of market research and opinion polling, for instance by George Gallup or Paul Lazarsfeld (Denzin and Lincoln 1994). For structured interviews the questions are asked in a strict order and usually in a predetermined wording. Usually the options for possible answers are pre-structured too. The interviewer controls the pace of the formal interview by strictly sticking to a pre-established questionnaire, and records the responses according to a coding scheme. In contrast to that, the non-structured interview is also focused on a particular subje ct, but there is no set of preliminary formulated questions. The interviewee is motivated by the interviewer to talk very freely about the subject and the interviewer can conduct the interview in a very informal way. The semi-structured interview is an intermediate form. The interviewer generally uses a set of primary questions that serve as a guideline. These questions are usually asked in a specific order and predetermined wording, to which the interviewee can usually answer in his or her own terms. The interviewer can then ask secondary questions, either from a pre-established set or additional questions that arise from the conversation, to acquire more information about a particular detail or aspect. This ensures that relevant information is not missed, and that the interview keeps focused on the subject while providing sufficient flexibility to include and discuss related issues not foreseen by the guideline. For non- and semi-structured interviews the interviewer usually takes notes or records the interview on tape for later analysis. Non- and semi-structured interviews are often used to acquire information in a field that is being newly explored, while structured interviews are more suitable to fine-tune knowledge on a field whose general features are already well established. For a critical discussion of interview methodology see Cannell et al. (1968). For the purpose of our study, specific parts of the interviews were conducted in a particular manner of non-structured interviews calle d narrative interviews. This was especially the case for questions like “how did you personally, and how did your company, get into the field of sustainability investment?” The idea of narrative interviews derives from the concept that people constantly tell stories, to others and to themselves, in order to understand the world. In narrative interviews, the researcher wants to get to know

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how the interviewees perceive their environment and their role in it. As Mishler (1986) points out, this means that we should learn to listen to the stories our interview partners want to tell. Narrative interviews are seen as genuine discourses between speakers, not as a kind of animated questionnaire method. The interview partners are allowed to ‘digress’ into stories or narratives. Whether such stories appear in an interview can be influenced by the interviewer one way or another: “… if we allow respondents to continue in their own way until they indicate they have finished their answer, we are likely to find stories; if we cut them off with our next question, if we do not appear to be listening to their stories … then we are unlikely to find stories” (Mishler 1986, p. 235). How can one characterize narratives, what do they tell us, and how can they be analyzed? Narratives could be defined narrowly as recapitulations of past experiences in a manner that maintains exactly the temporal order as they occurred. While this rather narrow definition of narratives might be useful for studies that aim specifically at understanding situations where, e.g., status relationships are ‘negotiated’ in a conversation that is later narrated, narratives can help us understand more than only this type of situation. They can tell us about cultural values and personal identities as experienced by the narrator. In the words of Kohler Riessmann (1993, p.2), “[i]ndividuals construct past events and actions in personal narratives to claim identities and construct lives.” If narratives are considered in this broader context, they can be understood to include also conversation elements that are globally and thematically coherent with the overall narrative, even if they do not follow the strict temporal order of this main narrative. Analyzing such narratives that occur in interview situations, whether invited or only tolerated by the interviewer, always is a question of interpretation. What is the ‘point’ of the plot of a narrative? Here it is helpful to view narratives as exemplifications of the personal identity the interviewee wants (consciously or subconsciously) to project in the conversation with the interviewer. In order to get to the essence of this identity exemplification, not only what is said in the interview explicitly has to be considered, but more general knowledge of values important in the respective culture are needed. Narratives can be highly informative parts of interviews, but only when they are interpreted as meaningful wholes from the point of view of the narrator, who uses them to exemplify her or his role in the context of broader cultural frameworks of meaning. The interviews conducted for this study are taped, transcribed, and analyzed for typical responses showing a general trend across the different interviews. In the following empirical sections, typical points of view of pension fund managers and external investment experts are illustrated with quotes from these interviews. In order to guarantee anonymity for the study participants, the ‘Chatham house rules of confidentiality’ were applied. This means that statements by the study participants are quoted in a manner that does not allow the connection of any statement to a particular person or organization.

3 P ERSPECTIVES OF PENSION FUND REPRESENTATIVES This empirical section discusses results from interviews we conducted with representatives of pension funds in Europe and the U.S. We found that environmental and social investment criteria, either expressed in terms of Sustainability or of Socially Responsible Investment (SRI), are taken into account by many pension funds for managing their assets. This can be seen as related to the long-term perspective to investment that pension funds have to take.

3.1 Why do pension fund managers take sustainability into account? 3.1.1

Long-term and short-term investment goals

Most interview-partners from pension funds stressed that by definition their institutions are focused on the long-term, as they have liabilities from pension claims arising some decades into the future.

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Well, we are very much long-term. The short-term investment stuff isn’t normally done on a tactical basis by ourselves. We do delegate our money to 11 investment managers and they obviously will take some tactical decisions. The only tactical decisions we make are rebalancing the portfolio as the markets drift. … Long term we’ve got liabilities that might go 50, 60 years ahead. We don’t think as far as that ahead. But we do have somewhat of a ten-year plan, which is reviewed every three years. (Pension fund representative, UK) Question: How do you … coordinate short-term and long-term investment policies? Response:I don’t know that we have short-term investment policies per se. I think we are very conscious about the fact that we are long-term investors and we try to take that perspective. So we have a strategic asset allocation and there aren’t very many tactical moves made, very very rarely. We tend to take a long-term perspective. (Pension fund representative, California) However, there are increasing pressures on pension asset managers to demonstrate high returns on investment also on very short time-scales: Question: How do you usually coordinate short- and long-term investment policies? Response: I mean this is a general problem… With any investment you make, there are usually short-term developments, which work against the long-term aim. This is [a phenomenon] you can’t reconcile and you never will. The cadence of performance measuring is getting shorter and shorter; we now have a monthly reporting, where we discuss this appropriately. … this goes to the respective persons of the investment commission. And we now have a meeting once per quarter, where we have to answer for what we did and where general questions are up. And there you certainly realize when there is something wrong about the performance, and then questions come at once. (Pension fund representative, Switzerland) Every quarter we have a meeting, but each month we [check] where [our investment pattern] should be and where it is, some [investment categories] are overweight, some are in range, and some are underweight. And basically we rebalance, using our new money if we can, and if not, than I take some money from those overweighs… (Pension fund manager, UK) All in all, ultimately, we guarantee the pension liability we hold for the future. For the longer term, our investments are… directed by our liabilities. In a shorter term we can deviate from that, we can have more in equities or less in equities... That is what we call tactical asset allocation. That is the reason… what we are all doing here, we are trying… to gain more return by … putting more in equities or more in fixed-income at certain periods. … In general we always say that asset liability long-term is 5 years and tactical asset allocation is a period of one year. However, in the past few years there has been a trend, and that trend is indicated by market circumstances and higher risk playing fields that these periods are beginning to become shorter. Now, I guess, you can fairly say that the long-term, the asset liability term is perhaps [a] 2- or 3-

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year horizon and the tactical asset allocation is 3 months or half a year horizon. (Pension fund representative, Netherlands) Performance is usually measured against aggregated stock indices, often the MSCI (Morgan Stanley Capital International) global stock index family. This implies that strategic investment decisions, which might be important to secure long-term returns, have to stay within the limits proscribed by these global benchmarks or standards: Question: Are there any special sectors or products, in which you just wouldn’t invest? Response: Yes, of course, the sensitive ones. Defense industry, there is something, casino, there as well, pornography, but there is nothing, that’s no problem. Well, the catchwords, there I leave my hands off. … I always have a problem that on the one side, I have to do the performance and the performance is my index and, in this index there are defense industry companies and there are casinos. But I don’t buy them because, it’s such a small part, I don’t care about it, at all. But when I now say ‘I don’t buy pharmaceutical industry’ (then) I have an enormous problem. In the last few months, if I hadn’t had pharmaceutical industry, I wouldn’t have had a chance to perform the Index [out?]. Well, this is the problem we have and, we have to take a look at both sides a bit, of course. (Pension fund representative, Switzerland) Sustainability, as a long-term issue, might imply conflicts with short-term focused investment decisions. This could mean that stocks expected to be performing well in the short term should not be bought because of long-term sustainability problems. But one of our interview partners thought that the main issue was rather the reverse: Question: … are there … investments that in the short term look nice, but if you look on a long-term basis, it doesn’t fit the sustainability portfolio? And how do you handle these tensions? Response: Actually it’s rather the other way round, that you are in the long-term convinced of something but in the short-term it doesn’t deliver what it should. And this is a phenomenon you are confronted with at all times, as a performance manager. … This applies also to the total market, not only to the “title level.” When we are convinced today that technology titles are attractive, then we buy today. And when they are once more 10% lower tomorrow and, in spring again 10%, well, then we have a need for explanation, that’s right. But most of the time the game is, that from a long-term focus – and as a pension fund we have to be long-term focused, of course – one does have short-term disappointments. (Pension fund representative, Switzerland)

3.1.2

Rationales for taking sustainability into account

In principle, the rather long-term outlook pension funds have should go together well with sustainable development goals. Well, I believe, the company believes, that essentially all citizens have got a responsibility to future generations. So people 200 years in time, 700 years in time, 7,000 years in time, will have to hope that each generation that comes in between has the decency to make sure that the bio-system, the animals, the overall life

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system really, will still be there. … That’s our basic belief. We know that we can’t make much difference, we don’t know in fact how much difference we are going to make, but we feel as we play some part. (Pension fund representative, UK) We think… that by investing in a sustainable way through all the assets we have, that in the longer term that will add more value, than by not doing it. … It’s the value creating which is… the prime goal. The secondary goal is that we would also like to change the world… (laughs) so to say. But we realize that this is not our task as a pension fund to do so. (Pension fund representative, Netherlands) This last quote emphasizes that, while successful long-term investment implies the need to keep environment and society from deteriorating, institutional investors can pursue this goal only if it helps to increase the economic value of their assets at the same time. The mandate of pension funds is to manage their assets responsibly on behalf of their members or ‘beneficiaries.’ This means that environmental and social criteria usually can only be included if they are closely tied to the financial bottom line. By law we have to benefit a fairly narrow slice of humanity, that is our beneficiaries, the people who will receive a part of our pension system and for whose benefits we’re making these investments. So we’re not in the positions to say, well X investment will benefit mankind if it’s not going to benefit our beneficiaries specifically in terms of making money for them, then we can’t do it. (Pension fund representative, North-Eastern U.S.) [T]here has always been this tension between wanting to be responsible but understanding that our fiduciary responsibility comes first. (Pension fund representative, California) But even in this clear economic perspective, sustainability criteria can have a rather important role in managing pension assets on behalf of pension fund members. Now, there are times in which we think what we are doing is also, in addition of helping our beneficiaries, it’s also benefiting mankind at the same time. For example … the Valdez oil spill, it’s cost the company billions of dollars and where did that money come from, the billions? It came from the shareholders, and the shareholders took the hit and which shareholder took the biggest hit? The biggest shareholders, that is to say us, the big institutions. So, the reason I’m relating this is everything that we do in terms of corporate responsibility, is related to the bottom line … is the company being hurt financially by something that is occurring or not occurring, will the company be helped financially by undertaking to do XY and Z? (Pension fund representative, North-Eastern U.S.) Such considerations include social issues just as well as environmental ones. … when a company like Texaco had some very serious problems in terms of racial discrimination a few years ago, we also were quite actively involved with them, to try to get them to rectify the situation. There are several reasons for that. Number one, of course, these kinds of problems … cost the company a lot of bad publicity, it becomes very damaging to the company, it can cause demonstration, consumer

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boycotts, loss of revenue. But also, two, what’s more important, when a company is … imposing, lets say, economically irrational criteria for hiring – that is to say they are not going to hire people who are black or Hispanic or whatever else – they are cutting themselves off from the services of potentially talented employees, and they are narrowing the pool of applicants, of the potential talented pool, that we feel can lead to less efficient business operations. Less efficient business operations means less profit, less profit means less dividend, the stock value can go down; once again we’re hurt by that. So when we oppose discrimination on the basis of race here in the United States, when we oppose religious discrimination where it occurs on the part of companies in Northern Ireland – that’s one of our projects we’re involved in - all of this activity is bottom line related, it has a bottom line rationale. (Pension fund representative, North-Eastern U.S.) And what the [external asset] managers tell us happily is that there is less of a conflict that you might think … . Money managers will tell you “You know what? Exploit labor… really is not a good business model” (laughs). I mean we would tend to avoid companies like that because we don’t think that is a good business model, it’s not because per se we are screening on labor rights. We just say this isn’t sustainable over the long-term, this is not a good thing. So I am hoping that there is less conflict between doing well and doing good than some people might say. (Pension fund representative, California) Considerations of social criteria go beyond classical topics of racial issues, and have interesting implications for example in situations of mergers between big corporations. … we now have an issue with Exxon … relating to sexual orientation discrimination. As you may know, Exxon merged recently with Mobil Oil Corporation. Mobil had a policy against discrimination based on sexual orientation. Exxon did not. When the two companies merged – in effect Exxon was taking over Mobil – the policy was cancelled. So they no longer have that protection, the people working for the company. We are saying that we’re taking this matter to their annual meeting, coming up early next year … we file this shareholder resolution … they will have to mail to all of their stockholders worldwide and so forth and we’re making a significant issue of this. Once again, because discrimination based on sexual orientation is economically irrational, and therefore it can lead to less efficient business operations. (Pension fund representative, North-Eastern U.S.) From many investors’ point of view, environmental and social issues are linked rather inextricably in what one can call sustainability. For the case of pension funds, which came to these topics via the tradition of ‘socially responsible investment’ (SRI), attention started often with social criteria to which environmental aspects were added later. ... the history of [our] involvement in these issues begins really with the antiapartheid movement in the mid-eighties. … Reverend Sullivan put forward some principles called the Sullivan principles for American businesses operating in South Africa, which we endorsed in 1984 … and then opted for divestment for any company that would not adhere to the Sullivan principles.

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… shortly after that, … a number of major environmental organizations in this country … formed what is called the CERES Coalition [Coalition for Environmental Responsible Economies] … designed to promote a set of principles that they put together, modeled after the Sullivan principles, and then they asked companies to adhere to that. … We’ve been quite active with them on environmental questions. … Now presently the CERES coalition has extended their scope to include work place and labor issues, worldwide. They started something that’s called GRI - Global Reporting Initiative … They are … helping to get corporations… to work out monitoring mechanism so the corporations can monitor what’s happening overseas in terms of their suppliers and their subsidiaries, environmental and also labor issues. Question: Great, so this is kind of a standard, which evolved as a proposition from an NGO and then was kind of endorsed by people like you. Response:That’s correct. Same thing with the Sullivan principles. (Pension fund representative, North-Eastern U.S.) The combined concern for environmental, social and financial performance is sometimes expressed in terms of a ‘triple bottom line,’ for which also the expressions environment-equality-economy or planetpeople-profits are used. The other thing is, to get it through really, we would like it to be economic, make more profit for us … at the worst, not cost in the future; planet – people – profits, is the triple bottom line as the expression is going, and we agree with that. Except for profits, we would substitute not losses, which is a little subtle change. … we do aim for profits ourselves, but we must demonstrate to our members not losses. They don’t want the conscience to cost them money. And I don’t think it needs to. I mean I personally would pay a little bit more, that’s my personal view. On behalf of other people’s money, that’s the deal we’ve done. (Pension fund representative, UK) Our focus is very much on the environment, but [the SRI consultants] who run the thing for us, extend to human rights, labor conditions, and those sorts of things… Question: … Some people talk about Sustainability and some people talk about Social Responsible Investment. For you, is there a big difference between them, how do these terms relate? Response: Between Social Responsible Investment and Sustainable … . To me it’s the same thing because we are focussed on sustainability and environmental issues. We see it as one. But we realize that to most people, social responsible investment includes human rights, this includes [our SRI consultants], working conditions, child labor. All very important issues, but there’s only so many hours a day and we rather focus on things that are achievable, we can actually make a practical difference, rather than pontificate. We want to do things by action, you know. Shaking, rattling cages, that’s what we’re after. It’s not that we are disinterested in child labor, but there has to be a focus. (Pension fund representative, UK) We used to say social responsible, SRI, and the last few months we, well we changed that to sustainable, because the term sustainable is more than only social

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things, when you talk about environment and human rights and weapon industry, we think that sustainable is more… yes is a better word. … It’s just a question of definition, it’s nothing else. It’s not that we changed our policy or something. (Pension fund representative, Netherlands)

3.1.3

Whose decision?

At which level within pension funds is the decision taken whether or not to take sustainability into account in the asset management process? We found that this decision does not necessarily correlate with the initial convictions of the individual investment managers concerned. In the following example, a pension fund manager would have liked to introduce environmental criteria in asset management earlier than his board of trustees let him do it. Question: [H]ow did [your pension fund] or how did you personally get into these environmental investment things? Response:I personally come from the 60s, and I remember reading a book on the limits of growth by the Massachusetts Institute of Technology, … I also used to get pamphlets on pollution. So, I had personal interest. In 1988 … I tried to introduce a green AVC [Additional Voluntary Contribution plan] then, but the trustees said offhand there is not going to be much interest. … I tried to do it early days, a little bit too early. (Pension fund representative, UK) Quite on the contrary, in another example a pension fund manager was forced by the investment policy to consider sustainability criteria before he was personally convinced that that was a useful approach. Let me be frank. I have, as I said, such a clause in the investment guidelines, which urges me to occupy myself with this [sustainability criteria]. And then I thought, we’ll do this once and then it runs one year, and we’ll see that it was worthless. That was my opinion. And with this I went there and looked at these [sustainability] funds, which are around and compared them one to another, bought the one or other and then: Surprise, surprise, the performance was quite positive! And above all the past performance was pretty positive. And then it began to interest me. … Of course this was also a learning process for me and the people around me. (Pension fund representative, Switzerland) Rather than being at the discretion of individual managers, the inclusion of sustainability criteria is decided at a high level within pension funds, for example by the board of trustees in the definition of overall investment policies. Why are sustainability criteria integrated into asset management policies set by some boards of pension funds? Rather rarely in our interviews, environmental or social views of the members of pension funds were directly mentioned as one of the reasons for taking such issues into consideration in the asset management process. This is the case in the following quote, while the fiduciary duty of generating high returns on assets is seen as a necessary condition to be fulfilled as well. The company got involved for two reasons, I guess. First reason is that our members, who are all part of the healthcare industry in the Netherlands… are from nature, I guess, very much sensitive to things like environmental and that sort of…

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tobacco, that sort of things, so I guess it’s our background and our members who gave us that spirit to do something with it. Secondly is that we have a fiduciary right as a pension fund to do our very best and to provide the best possible pension at the lowest cost possible. By doing that, you can only look at the profit and the profit growth of a company, but you can also look at a longer term and say, if this company does more on sustainability issues than another company, then ultimately this company will survive and will do better. It’s part of our fiduciary responsibility to pick those companies who will do better for our pension people. (Pension fund representative, Netherlands) A related reason is that labor unions, as the representatives of the workers and thus the pension fund members who currently provide contributions, are sometimes supportive of including environmental and social issues into decisions on pension fund management. … in the investment committee we have a unionist who of course welcomed this very much. (Pensions fund representative, Switzerland) Another issue mentioned was that corporations who aim to demonstrate environmental responsibility in their operations may want to align the management of their pension funds with this overall corporate effort. It’s not until the main board director who is responsible for the environmental corporate terms, and who is also a trustee [of the pension fund], wanted to unite policy - what’s the trustees’ policy on environment in the 96/97 period – that we were able to do some work … Once the director comes and asks for united policy throughout the company …. [Also], when an institutional shareholder says ‘that’s fine for your company, [but] what’s your pension fund doing?,’ at least it’s some coherent policy. (Pension fund representative, UK)

3.2 Two approaches to integrating sustainability concerns into pension management 3.2.1

Selective Investment

One approach pension funds take for including sustainability criteria in the management of their assets is what can be called ‘selective investment.’ By this we mean either selecting individual stocks according to sustainability criteria or, more often, buying packages of investments selected with a consideration of the sustainability profile of the stocks included. This can be mutual funds or similar instruments that are sold to a number of institutional clients by external investment service providers. And then I started investing. I mean, this is a ground rule in asset management: you don’t actually occupy yourself with a stock until you have bought it. Activities like checking the newspapers on what a title is doing, is of no use. You have to have the title. You have to have suffered with it, you have to have lost with it, you have to have won with it as well, so that you get a feeling for such an investment. And this of course we did. This is why I bought five [sustainability] funds in all, ...

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of which all but one are outstanding, they beat the index. My index, this might be important, is ... the MSCI [Morgan Stanley Capital International] World. ... I now have most of the funds, which there are in Switzerland. And these I observe a little bit. (Pension fund representative, Switzerland) Selective investment can also mean investing into portfolios of stocks that are managed specifically for this client, either in-house by the pension funds themselves or by external asset managers. That is the case, for example, for a major Dutch pension fund that holds overall resources of 50 billion Euro, of which currently a small part – 200 million Euro or 0.5% – is invested in two mandates with a focus on sustainability issues. [I]n general we don’t buy funds. We direct sums of money to managers, and those managers can be in-house but also external managers, and we say, you have … this and this index as a benchmark and you have to add value to that benchmark. And all the assets these managers buy are in the name of [our fund]. … There are some exceptions, but in general, 99% of our assets are directly invested in companies and shares, in the name of … [our pension fund] and not in funds. (Pension fund representative, Netherlands) How do pension funds that select parts of their investments according to sustainability criteria react to environmental problems caused by companies they hold investments in? One might expect that such pension funds would be inclined to divest investments in corporations that have encountered environmental problems. However, that is not necessarily the case. One reason for this is that getting out of a company after an environmental scandal has happened is usually too late for protecting the resources invested. I mean, Shell Brent Spar, something like that? ... What we would do, if something like that happened? Good question. Because when it has happened, … the share price has already dropped. In this case I’m interested in the performance and not in the environmental problem, that’s clear. And I don’t know, but I don’t think, this would be a reason for me to get out. ... Because it’s always the wrong moment. ... Of course, we can say, we sell the title with a loss, and people understand it, but in my performance as a whole I will then have a basis point less somewhere in the back, and then nobody will ask any more [about the reason]. Because of that I bear a greater responsibility. But I can imagine that we’ll have such borderline cases later on, and then we’ll have to think about these problems. (Pension fund representative, Switzerland) Another reason is that selling large amount of stock in companies that are in trouble anyway, especially if many institutional investors would do so at the same time, would increase volatility in stock prices which could hurt pension funds on the whole. Question: What do you do if you have your money in a company, which is not doing what you think they should be doing, in an environmental or social way? If they have … an environmental catastrophe or something. What do you do? Response: We first of all would like to enter into a dialog with the company. … We don’t go directly for the straight line. We don’t immediately sell that company. If it’s a big

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company that would mean that you’re going to disturb the market and the market price. Obviously we have a huge take in that company and that is not in everybody’s interest in that moment. We would go for the dialog. (Pension fund representative, Netherlands) So there is a certain ‘stickiness’ to investments. Even pension funds that would be somewhat reluctant to invest in a company for which implications in environmental and social scandals could be expected, would not immediately sell their shares in a company that actually has caused such a scandal. But a similar effect of irreversibility also occurs in the opposite direction. In the following example, a pension fund manager gave us his opinion about the conditions that led the sustainability funds he held to perform very well. Asked what would happen if these conditions were to change, he still thought he would continue to invest in such funds.

Question: You said you had been positively surprised by the performances of these funds or products. Do you think you understand why these products work so well? Response: Well, that’s pretty easy. As I see it, there are two reasons. On the one side, the pioneers... which are in alternative energies performed well. The second reason is simply that almost all [of these funds] had an overweight of technology stocks and an underweight of rather traditional stocks, for example heavy industry ... . And obviously from the technologies they had the right ones and not wrong ones, I mean no Internet companies or those, which now really lost a lot of money. It is linked to the oil price, evidently. I mean when the oil price rises, then one looks for alternative sources of energy. ... And anyone who has such a product will have his stock glorified, that’s the market. Then he writes a first study, then a second study and then all the titles are twice as expensive. All of them are quite small companies. They will stay very volatile, the titles. Now they are much too expensive, now I wouldn’t buy them anyway. Question: That means, if you now had a new allocation of quite a lot of money, then you wouldn’t stake on sustainability portfolios, just now. Response:With the know-how I have now? After all I think I would, yes. ... I could answer for that now as before. No, I did invest again and I’ll even invest once more this month. ... Question: If you imagine that the oil price might drop some time the next years, could you choose within the sustainable investments and within the sustainable funds, so that it’s not so dependent on the oil price ...? Response:No, I don’t think I can avoid that. ... there will be volatility from this side, that’s certain. But that doesn’t matter. Exactly the same companies, which produce alternative energies or the corresponding appliances, will surely outperform in the long term. Even if they had had an immense push, now it might be going sideways for two years ... and because of that they will underperform the market for two years, but in return it will go upwards again. I really look at this from a long-term angle. (Pension fund representative, Switzerland)

3.2.2

Engagement

The first approach to including sustainability criteria in pension fund management discussed above is to selectively invest in ‘sustainability leaders,’ be it by selecting individual stock, or by buying specialized 13

mutual funds or portfolios managed by external investment service providers for a single institutional client. However, there is a second approach towards integrating social and environmental considerations into the management of pension assets. In this second approach, decisions which companies to invest in are made regardless of sustainability issues, but these issues are then integrated in the way the funds as owners work with the companies’ management. I guess in the end, what [our pension fund] tries to do, no matter how the stocks end up in the portfolio, is be responsible owners which is why we take all the proxy voting seriously and why we take our corporate governance efforts really seriously. (Pension fund representative, California) For working on social, environmental and other issues with the management of the companies in which investments have been made, the terms ‘engagement’ or ‘corporate governance’ are used. Obviously, engagement and selective investment are not mutually exclusive. Quite on the contrary, the managers of sustainability funds often work closely with the companies in their portfolios on social and environmental issues. But this is different from what might be termed a ‘pure engagement’ policy for asset management, where no selective investment with regard to sustainability is made while these issues are actively pursued with the companies’ management. … we are investing in every single company in the UK and in a lot of companies in the USA, we have an engagement policy. … There are two essential policies we think. You can either vote with your feet, not buy stock you don’t like or sell stocks you don’t like, or you can invest in any company, but when they do things you think is beyond what they should be doing, you can write them. The ultimate thing is … you can try to change the management. You’re the shareholders, you’re the owners, you would change the management. So it hasn’t come to that, not in this country, it has in the USA I understand, and it has in other areas of corporate governance in this country. (Pension fund representative, UK) And indeed, pension funds in the U.S. have been rather active in shareholder activism, including issues of environmental and social responsibility. … we have over a billion dollars invested in Exxon Mobil. And you remember some years ago, they had this oil spill. We, as major investors, got on the company’s case after that and we campaigned for them and got them to agree to put in an environmentalist on their board of directors. The reason for that was that if environmentally sensitive projects would come up to the board for approval … that there would be an outside independent director who would be technically able to evaluate these projects … (Pension fund representative, North-Eastern U.S.) But there is an increasing trend also within Europe towards a more active policy of major institutional shareholders in seeing their long-term interests in the companies in their portfolios protected. [O]n the whole corporate governance and engagement policy, because that’s what I’m talking about when I say dialog, we have good experience. Because we are a big pension fund, we have power. Company directors are indeed increasingly paying attention to shareholder values, and they are more and more inclined to

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listen to their investors, absolutely. It’s a whole new trend; a trend that started only five years ago, but that is increasing a lot. (Pension fund representative, Netherlands) Chances of pension funds to encourage management to pay more attention to long-term goals are increased if these funds pursue engagement policies not in isolation, but in collaboration with one another. So, in the Netherlands, for example, we are part of a group of pension funds who do corporate governance, so that means that we have to go to annual meetings of a company and have to vote for certain things as an investor. (Pension fund representative, Netherlands)

3.2.3

How could these two approaches develop in the future?

Selecting investment portfolios specifically according to sustainability criteria is a more recent approach than pure engagement policies, which have already been popular for a long time in the tradition of socially responsible investment. It seems that these pure engagement policies are somehow more related to concepts of protecting investments from risks. Selective investment, on the other hand, seems more often motivated by the wish to profit from exceptional performance of stock in companies preparing actively for the future, rather than by risk control considerations. By investing in sustainable assets compared to not sustainable assets it’s not a question of risk control. You can even say that it is more risky to do so, because, in general, all the markets in the existing benchmarks are not sustainable. (Pension fund representative, Netherlands) It may be expected that practices of selective investment or ‘screening’ will gain ground in the future. However, a major growth of selective investment may depend on the ability of its suppliers to address reservations of pension fund managers who today on purpose use pure engagement policies. One thing that came up last week in the conference is that a lot of work has been put into screening, whereby a new style of investment would be to find those stocks which you think, on environmental grounds, will do well in the future because of their green fits. … I’m quite certain that this style could do well, and that … environmental funds as we see, can do well. But my problem with that is, if they develop too well, people start paying more and more money for these companies and eventually they will overpay for them. … And then these will become cheaper and cheaper [again]. I don’t want this … flip-flop, in and out of fashion, the green thing … in and out of fashion. … That’s not what we’re about. That investment process itself is only sustainable on a cyclical basis. We … engage with companies … Well, I don’t care if they do [screening] as well, as long as they recognize that. When it’s down here and investment funds with green funds all start performing badly, it doesn’t bring whole process into disrepute. That’s what I’m worried about. (Pension fund representative, UK) Another argument given was that, at least if selective investment is done in a ‘mechanical’ way where the ‘universe’ of stock to consider is limited by a prior consideration of sustainability aspects before a balancing of positions is taken only within this restricted universe, could be too black-and-white.

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A lot of people who do social responsible investing have screens. And what a screen does by its nature is, it gives a 100% weight to a factor. And there might be a factor that you want to consider and weigh in your investment decision. But you don’t want necessarily to give it a 100% weight because there might be other offsetting factors. And the other problem I see with screening is [that] it is a point estimate you have to decide ‘yes’ or ‘no.’ So it doesn’t tend to look at the trend, whether the situation is improving. And screens often depend on past data, so you can have a staff like ours find the 2000 and 1999 book, which is based on data, even before that, and try to make a determination on these. Or you can deal with a money manager who was visiting the country last week and has a better sense of the trends and what is going on. So I think those are sort of the question when you try something like this. (Pension fund representative, California) One approach to socially responsible investment that was mentioned in our interviews was actually the direct opposite of a selective investment approach where one would focus only on companies doing well with regard to sustainability. In this other approach, one would actually target investment at companies that are environmental and social laggards, and then work with them in an engagement mode. We don’t run screened funds. We’re heavily indexed, we have major holdings, we are on the top ten or top twenty shareholders in most of the largest U.S. based corporations … if there are problems, then we try to get involved and sometimes we try to get involved before there are problems … What we are doing systematically, we are identifying certain sectors where these problems are more serious and then we’re going down the list and are approaching all of the companies that we have major holdings in, in these sectors. … we work very closely … with the Interfaith Center on Corporate Responsibility [www.domini.com/ICCR.html], the Church groups. These are the major U.S. churches, catholic churches, protestant churches and Jewish … religious organizations, and they have taken all their investment monies and they buy everything. They do the same thing as we do, they buy everything. … we have an alliance with them over a number of years now and we work very closely with them. And we bring to the table very large holdings, they bring to the table a moral position, which carries a great deal of weight as well. In fact, if there is a problem with a company, they’ll actually go out and buy this stock. I mean, there’s two ways of dealing with this. You can go out and sell the stocks. Then they have the philosophy they go out and buy the stocks, they can get access to the annual meetings, they can get pressure on the companies to change it’s way. I think that’s another way to do it and it can be quite effective. (Pension fund representative, North-Eastern U.S.) There are various combinations of a selective investment approach and a pure engagement approach that we found. One of these is to manage the bulk of the resources according to pure engagement policies, but to offer ‘additional voluntary contribution schemes’ where selective sustainability investment is one of the options the members can choose for the management of their additional pension resources. We do have for individual… we have, in addition to our pension fund, we also have … deferred compensation investment funds, which is aside from one’s pension, it’s a deferred pension plan and people can pay in up to 7.5% of their income each year into that fund and that is invested in several investment products

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which we give the individual member the choice, the individual employee the choice. One is … a social responsible fund … (Pension fund representative, North-Eastern U.S.) A similar approach that we found was taken, for example, by the Dutch pension fund mentioned earlier. From an overall amount of 50 billion Euro under management, 4 billion are invested according to pure engagement policies, and 200 million in selective investment products with a sustainability focus. Taking these two approaches together, close to 10% of the resources of this pension fund are managed with consideration of sustainability criteria. Some of our interview partners thought that there is a considerable potential for growth of sustainability asset management beyond this point. Question: How do you see the future growth in sustainable investments? Response:Yes, we think that it is a development, which you cannot ignore anymore. It’s only going to … increase. I think in 10 years time it’s a general part of the investments … then it has become at the same level as the profits where [we] look now … when we judge a company. Ultimately it will not only be profits, but it will be sustainable profit that we look at. … And we think that we are at … the beginning of it all. (Pension fund representative, Netherlands) You didn’t ask me what percentage of the whole we invest [in sustainability funds] ... Of the shares, that’s somewhere between four and five percent. Question: Do you think this will rather increase? Response: It is increasing. Question: Where do you think would be too much? Response: Yet I can’t yet tell that today. It can go up to 100 percent. I mean, once such criteria exist, which allow me to choose a title with my know-how based on a rating, then it may be 100 percent. ... (Pension fund representative, Switzerland)

3.2.4

Transparency

In the past, taking sustainability criteria into consideration or not has usually been an internal discussion within individual pension funds. However, a recent regulation in the UK has started to change that drastically. Since July 2000, U.K. pension funds are required to disclose in their Statement of Investment Principles (SIP) “the extent (if at all) to which social, environmental or ethical considerations are taken into account in the selection, retention and realization of investments,” and “their [the trustees’] policy (if any) in relation to the exercise of the rights (including voting rights) attaching to investments.” (For more information on that, see www.hmso.gov.U.K./si/si1999/19991849.htm.) This regulation was developed with the active support of pension fund managers. Question: There is a new regulation on [socially responsible investment] disclosures in the UK. Does this affect you, what do you think about it? Response:… We are one of the few pension funds who were doing something before this time. When … the pension minister at that time, said he was minded to introduce this regulation, we actually supported him by making a statement in the Financial Times for everybody to see … (Pension fund representative, UK)

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This disclosure regulation in the UK has the potential to lead a trend in different countries at least in Europe. I think it’s a first step they have made in the UK. … I think that ultimately every country will take these kinds of steps. Also here in the Netherlands there are talks about it. …. I regard it as a good thing, … (Pension fund representative, Netherlands An important point about this UK rule is that it prescribes disclosure or transparency, not any obligation imposed by government to take specific investment policies. This character of the regulation, making transparency obligatory, while leaving sustainability asset management policies a voluntary – if public – decision by pension funds seem to be a central element in its acceptability to institutional investors. Question: … this regulation is a transparency regulation. It doesn’t force pension funds to do anything, it just forces them to disclose something. An alternative would have been … guidelines how much investment in Sustainability should be. What do you think about these different approaches? Response:Well, the big opposition in the industry was because they feared direction of investment rather than disclosure. I think one of the things we have to be very careful about, is to build on disclosure and make sure there is some positive movement. I think if people want to take things too far by direction of investment, it will have a counter productive effect, it will put the whole thing in reverse. It’s much better that pension fund do it on a voluntary basis, even if they are very slow, because I believe a willing bird flies much farther than a thrown stone. You don’t want people doing things because they’ve got to, I don’t think. Question: Do you feel they would do it badly then or they would oppose the whole thing? Response:They would oppose it. We know that. (Pension fund representative, UK) … Because if that interferes with the fiduciary right … of a pension fund to provide a healthy pension and if there is some kind of government rule preventing that, because this pension fund can’t invest in that company, yes, then that is difficult. I don’t think that it will go that way, but I do think that there is a certain responsibility put upon pension funds, to show to others, that they do something good about it so they get a good press and at that moment also get more members. So that would be done that way but … it wouldn’t be a law upon that, that’s impossible. (Pension fund representative, Netherlands) The emphasis on transparency, rather than on obligatory investment policies, could mean that the UK rule may also act as an inspiration to North America. Question: You probably heared about the new regulation in the UK, that pension funds there are required to disclose whether they have any social responsible investment or environmental strategy, and if so what … they are doing. Do you think this kind of transparency regulation is something that is positive? Response:… I haven’t really thought about it. It would sound like it is. (Pension fund representative, California)

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Pension funds could also become advocates for transparency rules beyond the investment sector itself, as it is in their interest that information on long-term risks is made as public as possible. Question: … some people have proposed that companies listed on a stock market should be required to disclose environmental and social risk together with the financial risk, to the stock exchange ... Response: … it sounds like something that would be helpful. I mean, we generally have taken the position, … the more information that is available to shareholders, that the company makes available, the better it is for us. (Pension fund representative, North-Eastern U.S.) Question: … some people discuss whether the Securities Exchange Commission … should demand, integrated into the financial disclosure, an environmental risk disclosure by the company as part of their being on the stock [exchange]. What do you think of that? Response:Well, I basically think that it’s in interest of everybody for these things to be codified as best as we can. This is a global issue, … I’m in favor of a global stock exchange where companies have global listing standards, a global accounting standard and other global standards … where we can see that these companies coming to this global network, … and they all have to give this sort of information that society wants, what the shareholders want and society. They got to recognize that, although they are owned by shareholders, they’ve got responsibility to communities, to societies generally. I think that we need some sort of global governance, some global network that brings these sorts of pressures on companies. Yes, I very much favor it. (Pension fund representative, UK)

3.3 The use of sustainability information 3.3.1

‘Standard of proof’ of sustainability information needed

The use of sustainability criteria in pension fund investment is voluntary, and ecological and social factors are seen as drivers for economic value rather than as isolated goods in themselves in this context. It is left to a large extent to the pension fund representatives to judge what environmental or social actions by the company could have repercussions for shareholder value. [W]e have it laid down in the investment guidelines that we shall consider sustainable stocks. But it’s not defined so that this has to be a percentage X, or until then and then, nor is it formulated more closely what sustainability actually is. So as a matter of fact, it is up to our team how we want to do this. (Pension fund representative, Switzerland) For this reason, the ‘standard of proof’ of sustainability information needed for making investment decisions is much less rigorous than in academic discussions aimed at supporting diplomatic negotiations: … very frequently we can raise an issue in a way that we do not have to present mountains of proof, we are not trying to win a legal case, necessarily. For example

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we can say, … ‘it was reported in so and so journal that XYZ is happening, in light of this allegation, we would like the company to appoint a special committee to report on this, for shareholders.’ … We are raising the issue in a way that can get the attention of the board of directors, of the company, publicity and so forth. And we don’t necessarily have to have the kind of proof that you would need of the truth of the accusation, … when you would go into the court, let’s say. (Pension fund representative, North-Eastern U.S.) At the same time, institutional investors have to grapple with very complex problems and tradeoffs if they really want to integrate sustainability considerations into their investment decisions. … we have seen things where we think it is terrible that thirteen-year-old girls are exploited in these factories, so we lay them off, and then consequently they go into prostitution. So what have we accomplished? So, I don’t know the answer … (Pension fund manager, California)

3.3.2

Current sources of information

Pension funds which include sustainability criteria into their asset management policies often do this by delegating related decisions to external providers of sustainability investment services. Some of these ‘sustainability contractors’ offer mutual funds or individually managed portfolios of corporations with ‘good sustainability record.’ Question: What type of product or type of [sustainability] information do you need at the moment? Response:We don’t need anything but funds. ... in this manner I have actually delegated the whole decision process. (Pension fund representative, Switzerland Others offer support to pension funds engaging in corporate governance activities, for example regarding environmental and social reporting by corporations. … it’s pretty superficial what we are doing and we can’t do it ourselves. So we use an agency, … they produced a 166-page report analyzing all the main companies by various factors. And gave nothing more in the report to us than a blob against whether that company was reporting it’s position. Now, it’s still pretty superficial and all we are trying to do at this stage is finding out what the key factors are and get a blob against their name. And I’m using the word blob to show how unsophisticated it is at the moment. … (Pension fund representative, UK) In addition to commercial providers of sustainability information, NGOs are also an information source for decision-makers in the pension fund industry. We contract with several outside research organizations who then provide us with the research we need. … Of course we also read the newspapers like everybody else and also people will approach us with issues. We get e-mails from different NGOs who approach us all the time for support, …in other cases we might reach out to NGOs for support as well. Also we attend conferences … so we basically

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get around. But we rely on these outside organizations that we contract to do the bulk of our research on these issues. (Pension fund representative, North-Eastern U.S.) A main reason for this relia nce on commercial sustainability service providers or NGO partners is that judging which sustainability issues in which sectors or corporations deserve attention from an investment point of view needs more specialized knowledge than most pension funds have available in-house. Everybody in my team is an economist. This is actually normal in asset management. Of course it’s true, if you want to assess something like this, you need natural scientists in principle. And this know-how we don’t have, and so we have to take it from the banks, which manage these funds. (Pension fund representative, Switzerland) And pension fund managers are very conscious of the fact that for them sustainability may be important, but only as a supplementary topic supporting their main task of managing long-term resources carefully and profitably. We don’t have the time, we are not full time environmental people, we need pension funds for beneficiaries, you know. (Pension fund representative, UK) Academic sustainability assessments were usually not seen as major sources of information by our interview partners from pension funds active in sustainable asset management. Question: Do you think it’s important to you, to know a little bit, what the more scientific sustainability research is doing or, is all you need the funds and that’s enough? Response:It might be interesting but it’s not important enough to me that I’d invest time. It would interest me but at the moment I don’t have enough time. Question: You sort of delegate this part to the people, who sell you the products? Response:Yes, exactly. These are the same people, who have these contacts to the universities, and like this I have in principle already guaranteed that the know-how flows in, at least I hope so. (Pension fund representative, Switzerland) When we actively asked about the potential of academic sustainability assessments for supporting investment decisions in the future, a number of conditions were given that would have to be fulfilled for such assessments to be useful to pension fund managers. We will discuss these conditions later, after looking into issues of legitimacy, credibility and transparency of sustainability information used today.

3.3.3

Legitimacy and credibility of sustainability information

Legitimacy of the process leading to the production of sustainability assessments was not an issue raised by any of our interview partners. This may be a consequence of the fact that the use of sustainability criteria in pension fund investment is voluntary. The goal here is to not to reach binding international agreements like the Montreal protocol on ozone depletion, which need a high degree of process legitimacy, but rather to design investment policies which benefit the specific pension funds in question. It might be that, if pressure from pension fund members on sustainable investment of their pension resources would become stronger, legitimacy could become an issue in the future. But at the moment, the legitimacy

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of processes to produce sustainability assessments and its political acceptability or perceived fairness is not even on the radar screen of pension fund managers in general. Pension fund managers are more aware of issues of credibility, that is believability of accuracy and scientific or technical quality of the information used. In the case of information picked up from the media, the general reputation of the source in combination with a common sense assessment of the plausibility is used as a first check whether the information should be taken seriously. Question: How do you judge the quality of the accusation? I mean, if just some obscure journal published... Response:That’s true, it does, to an extent, depend on the source. I mean, if … some ... organization comes out with something, you know saying that X company is plotting with the queen of England to smuggle drugs into the U.S., that’s not really a credible source. But if something is printed in the Manila Times, about the bad condition of some factory in the Philippines, that becomes something that we can take and raise question. We can ask the question. If something is printed in the reputable scientific journal in Europe or in the U.S., once again that’s something we can take and we can raise the question. (Pension fund representative, North-Eastern U.S.) In relation to sustainability information and related investment services offered by external asset managers and consultants, pension fund managers don’t seem to see credibility in general as a major problem in the foreseeable future. Question: So how do you judge whether the offer is, so to say, correct in content, relating to what these people claim that they are doing concerning sustainability...? Response: How do I guarantee that these funds keep to what they say? I mean, I talk to these people, look at the portfolios and look at the titles in there, I may ask myself some questions, why is this [title] with it, why isn’t that one... Question: ... if sustainability is included in the policy of a pension fund, you might have to justify that the part you have invested in this segment has been in fact invested sustainably. Do you have to justify as well, how good the quality was of portfolio or index, what ever, or do people believe this automatically when you have spoken to the sellers? Response: ... If I just buy a fund with this name, then people believe it more or less. So there I have absolutely no problem to show it outwards. They all understand this, and it’s considered fine like this. (Pension fund representative, Switzerland) Some people in the commercial investment-consulting scene are beginning to see credibility as an issue that needs attention, and that could provide a business opportunity. However, at least at the moment, the need by information users at pension funds for advice on the credibility of sustainability information seems low. Question: How do you judge the credibility of this information, because it’s from the outside? Response:… we don’t. We trust those managers, which we appointed that they have the expertise and strive to get good information there. So we don’t get an audit on, for example, their investigation in certain companies. I know that accountants like

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KPMG and PricewaterhouseCoopers, they try to get a hold of this piece and say, … you should get audited information whether that’s incorrect what they are doing. I don’t think they really have a good point in that, I don’t think … we will appoint them to do an audit on this information. (Pension fund representative, Netherlands)

3.3.4

Using academic sustainability assessments in the future? Saliency and transparency

Academic sustainability assessments, and results from sustainability science in general, have a great potential to support pension funds in making informed decisions on sustainable asset management. In a few cases, this potential is already beginning to be realized. Question: Looking into the future, there could also be the academic field of getting information … . Could that be of any use for you? Response:Absolutely, yes. Already there is a synergy with the academic field. We have … certain Universities at this moment have a chair, … a person who teaches on sustainability. That person is sponsored by the University in combination with some companies. … It’s a chair within the University and students can follow that route if they like, they can be taught that material. And already two Universities [in the Netherlands] have this institution and from that academic field there is a lot of input on the area of sustainability. We use it … as a discussion pla tform. We regularly meet those professors and they really have an input on this subject. Yes, we already use it. And also worldwide, I know [that] in the U.S. it is a very big topic, also in academics… there is a lot of synergy. (Pension fund representative, Netherlands) However, usually pension fund managers currently make little use of academic sustainability assessments. A major problem seems to be that issues that pension funds need to know about are not really addressed in academic sustainability assessments. That is, there is a fundamental problem of saliency. What would have to be changed so that academic sustainability assessments could become more salient for institutional investors in the future? One issue is that information on global or regional sustainability trends, in other words on key areas of sustainability concerns, has to be combined with information on activities of specific companies in order to allow investors informed choices on selective investment or engagement activities. Question: … there is … the more academic research about sustainability issues … . Is this kind of academic research useful for you, either today or later stage, or is it too much in the fundamental research? Response:… If the theory can be translated into a systematic approach to say, these are the key areas that you need to look at, these are the most important areas, can you as owners of these companies do something by bringing pressure on the management, and on the corporate governance agencies to recognize these were the main things. Then yes, we could do that. … I think we can marry academic and practical, as long as the academic is accepting… we got to make sure that it really is practical as well, otherwise it becomes entangled with being too way-out, it maybe right, but you have to convince as well. If we do that, we can bring it into the mainstream corporate governance work. Question: What should it achieve to be practical for people like yourself?

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Response:… It needs to be focused. We can’t do too much. … It needs to be practical by focussing on key areas, and then identifying the key companies, and then helping us write letters and attaching pamphlets or whatever. And basically from the companies’ point of view, they want it to be achievable, so it’s measurable and achievable. (Pension fund representative, UK) Breaking sustainability assessments down beyond the country level, so that they can be connected to actions of companies, is important to pension fund managers. … there would be certain situations that we don’t want to be involved [in], in terms of bad labor or bad environmental practices … The debate seems to center around “Do you make these decisions at the country level or at the company level?” So that is one area that is fraught with difficulty. … I believe – and not all of the board members would agree with me – that you have to look at the company and not at the country [level]. Because a country can have good environmental or good labor laws but they are not enforced. Or you may have a company that is doing a little more than it is required … . So I think a lot more is company than country [level]. (Pension fund representative, California) The same holds for major topics in the sustainability arena. In the end, it is the link to the company level that allows pension fund managers to use sustainability assessments in practice. Question: Do you think climate change issues are important for your holdings at all, or is it a kind of thing that will fizzle away? Response: It depends on several facts, it depends on what role American Multinationals are playing, it depends on what information we can get, what specific information we can get about what companies in our portfolio are doing that may have a harmful impact. It also depends on some indic ation that the impacts are harmful, whatever X,Y and Z company is doing, and then we can move forward. (Pension fund representative, North-Eastern U.S.) That is not to say that, depending on the issue, sustainability information on the country and sector level could not also be highly relevant to decision-makers in pension funds. [I]n the past we haven’t invested in South Africa. Well, that’s an old story almost. We also don’t invest at this moment in Myanmar, or Burma … Question: But you rather don’t invest in countries, for the whole, or just not in companies in those countries? Response:Both, both. We said that for the human rights we will not invest in [certain] countries, and we said for example with regard to the weapons industry we will not invest in these and these companies. (Pension fund representative, Netherlands) On these higher aggregated levels, concerning sectors or countries, there are a lot of complex sustainability questions salient for pension fund managers that academic research and assessment efforts could provide deeper understanding on.

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Question: Do you also look at, let’s say, what academic science says about these issues … Response:One thing that is difficult... if you look at academic research … is to find economic linkages. … Like, everybody would agree that political stability is a good thing but … [s]omething can happen in a country that is short-term destabilizing but long-term is going to be beneficial in terms where we are seeing where this country is going … Well, to give a crude example. I would say … that we prefer to deal in countries with democratic regimes. Actually, you know, autocracies can run pretty smoothly in terms of political stability (laughs). A democracy … at least from the beginning, can be a little less stable, and perhaps you would like to be a little less stable, because you feel in the long run you are going to be better off with a democracy. … one of the debates we have gotten into is economic freedom versus political freedom. And there is not a lot of political freedom, I’m given to understand, in Singapore but it is very free economically. Whereas India has a lot of, I’m given to understand, political freedom but not much economic freedom. (Pension fund representative, California) However, such information on regional or sectoral sustainability issues has ultimately to be connected to the company level if pension funds are to profit from sustainability assessments. Question: If you look at … global environmental change, and if you could have a Christmas wish of, lets say information you could get on future trends, which could come out of either a research organization or a University. Is there anything you would like to know about this to help you scouting? Response:We’d like to know, we would like to be able to flag the problems, related to specific companies. For example, we would like to be able to hear if one of the multinationals is out doing something they should not, in Africa for example. … For example on issues like the Chad-Cameroon pipeline, ... Exxon is involved with that. We have potentially a lot of influence with Exxon, so then we can take that and use it. Something more general, something more amorphous, that is not really company-specific is much more difficult for us take that and translate that into action immediately. Question: I mean you could get information about a company or information about a sector. Let’s say this sector... Response:That’s exactly right, for example the apparel [or] the toy industry, in globalization. That kind of research is very helpful to us. Then, of course, if someone does academic work on globalization of the toy industry, they are going to be referencing a lot of specific companies. That is going to be helpful to us if we are going to find out [a certain company] is doing X in South China, that is very helpful to us. (Pension fund representative, North-Eastern U.S.) If sustainability information with a connection to the company level would become more widely available, that could fundamentally change the way in which institutional investors manage their assets. One might think that this could threaten commercial suppliers of sustainability investment services. But there are reasons to believe that such widely available information would rather give a boost to the overall sustainable investment industry, and not displace services provided currently. It’s becoming more and more a criterion, now we are doing this through the funds, that’s clear, but maybe some time there will be guidelines on this subject [of 25

sustainability], or the investors unite and lay down such guidelines, ... and then this is something the companies [in which investments are made] will have to take care of. ... Question: Do you think, such guidelines, if they come some time, would be like an alternative to the funds, or would this be an addition in order to deal with the funds? Response:I mean, this would make direct investments possible again. I can’t go and analyze a company on the basis of sustainability criteria, for this we don’t have the knowhow, but when I know that the company meets these criteria and gets a positive check, then this of course is a sign that the company is o.k. for me. Such a thing might happen. Question: And if it came, you might go less into funds...? Response:No, in this case I would certainly keep the funds, but I would change my own investments a bit. ... Every company nowadays has for example, well not every, but a lot of companies nowadays have a rating for the outstanding bonds, a quality rating which characterizes the debtor, and this of course could be possible for sustainability as well. ... This would be brilliant, of course. Because, if something like this existed, I could have written into my investment guidelines “may only buy titles with a sustainability rating of at least so and so.” (Pension fund representative, Switzerland) The possibility of such a successful growth of sustainable investment, changing the way mainstream institutional investment is done, will depend critically on the transparency of sustainability information made accessible in the future. It has to be neutral, come from a neutral side, and it has to be transparent. ... what are the criteria to exclude titles or to exclude industries and on the other hand to qualify titles ... What are these criteria? That’s extremely difficult. ... But if one wants to find acceptance somehow, one has to disclose it and make it clear, make it transparent. (Pension fund representative, Switzerland)

4 P ERSPECTIVES OF EXTERNAL ASSET MANAGERS AND SUSTAINABILITY INVESTMENT CONSULTANTS Pension funds often work with external partners on sustainability investment, like asset managers receiving mandates to manage parts of the pension funds resources for a specific amount of time. Other external partners working with pension funds and with external asset managers are providing mainly consultancy and information service on sustainable investment. For reasons of simplicity, and also in order to be better able to guarantee anonymity in quotes, we designate both groups – external asset managers and investment consultants – as ‘investment experts’ for the purpose of this paper.

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4.1 Why do investment experts take sustainability into account? 4.1.1

Long-term and short-term investment goals

Our interview partners from Asset Management firms and investment consulting companies defined different time horizons for their investment strategies. The companies we spoke to all offer (at least a small part of) their services as sustainability investment or socially responsible investment services. Thus, it is not surprising that they focus on longer-term investment goals compared to some other more shortterm oriented investment service providers. In principle we certainly have a long-term investment approach. (Investment expert, Switzerland) We view ourselves as long-term investors. Typically we hold the stock of a company for an average of four years. If you assume … a 25% turnover a year, so your average holding-time is roughly four years. So naturally, when we are thinking about a position, we have to look at the risk factors over a sort of 1, 3, 5, … 10-year basis. (Investment Expert, North-Eastern U.S.) Some also saw themselves focussing on the ‘medium-term,’ but the definitions of what was seen as medium and long-term often overlapped. The ‘medium-term’ for which strategy is developed is about three years. (Investment expert, UK) As Asset Managers we have a medium time horizon anyway. … Eighteen months to three years, so three years, yes. We will always have some long-term core stocks in our portfolio, primarily stocks with good management, that are leaders in their field, that have got good earnings momentum and so on. But we also have a quantitative screen that we use ourselves in-house and that will very often trigger the additional shorter-term stocks to the portfolio. (Investment expert, Netherlands) Even though the time horizon for asset management has become shorter during the last years because of market circumstances and higher risks, not all Asset Managers are following the trend of very short tactical asset allocation. As I said, we don’t make calls saying the sector is going to substantially outperform another sector, because we feel we can’t time it. Very often you’ll see industrial stocks, paper stocks or something like that performing for three months it happens very quickly and it’s over very quickly - so we won’t tend to try and chase that. (Investment expert, Netherlands) When is the right time to step in to invest in a certain company? There is a conflict between long-term winners, which are not yet performing well, on the one side and companies, which are performing well in the shorter term but which have sustainability problems in the long-term, on the other side.

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And we may say “well, this is a terrific company long-term” you know, but in the short-term it is not right because the stock price dynamics are not with the company, because there are other issues that are more important in the short-term versus the long-term to their financial performance or their appreciation potential. So it’s complex and I don’t think there is any easy way, and there are tradeoffs. I mean, long-term - everyone would say, we are moving to a direction with less reliability on oil [and] traditional fossil fuels - but does that mean today [that] you forgo any investments in the large oil companies? To us that doesn’t make sense, because it’s probably some of those large companies, that are going to allow us to make that level of a transition. (Investment expert, North-Eastern U.S.) Selecting the right moment for investments is crucial So if we look at a company today and it’s extremely expensive and in the coming six months we expect disappointment from an earnings perspective, we’ll say, no, we don’t… we in principle may like the business they are in, but we don’t feel that this is the opportune moment. If we look at one that is very cheap relative to its peers, we may actually decide, well actually a lot of the bad news that we were expecting in the coming months is already in the price and we’ll move into that stock, but we need to be very comfortable on the product, on the management, on the strategy of the company. (Investment expert, Netherlands) Only if the moment for investment seems right from other considerations as well investments into companies be made which are seen as sustainability leaders. Now, if you would have asked us about energy two years ago, we would had the same answer that we have today. We think BP and Shell are very responsive and are moving in the right direction. But two years ago it made no sense to hold oil companies because of the market conditions. Now today that is a different story! (Investment expert, North-Eastern U.S.)

4.1.2

Rationales for taking sustainability into account

There are two different reasons why one could take social and environmental criteria into account in its investment strategy. Some people are convinced that by including sustainability criteria, you can select winners with high growth potential. [O]ur rationale is, (that) if you look at companies that are well managed environmentally and socially, as well as financially, that you will get a better return over time. … (Investment expert, Netherlands) A slightly different rationale is to control risk of exposure to environmental or social scandals. Whether the motivation is to select high growth stock, or rather to lower the risk exposure, sustainability is ultimately integrated into investment services offered to pension funds and other clients because it can improve returns on investment. This also means that if sustainability criteria are taken into account, this will be done in combination with other financial considerations.

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… [A]lso our approach is that we want to make sure that the companies we invest in from a sustainable or social responsible perspective, are also financially sound. Because a lot of investors initially said, oh well, if I exclude too many stocks or if I favor stocks that are, you know, maybe too relaxed about profits, then I loose out and I can’t match my liabilities. (Investment expert, Netherlands) Environmental and social considerations are closely linked in what is called sustainability investment by some and socially responsible investment by others. While these terms can sometimes be almost exchangeable, there are differences in emphasis that are related to the different history of these investment policies on the two sides of the Atlantic. Well, I think social responsibility and sustainability are basically the same thing. Environmental, I think, is just a more narrowly focussed to the environment. Social responsibility grew out of the religious movement in the U.S. Sustainability is a new term because the so-called social or ethical investment market in Europe is relatively new. In the U.S. it’s always… you know, we have a 25 years of history that you just don’t… but it embodies the same thing: socially responsible investment …looks at workforce community and environmental issues. It has always looked at a broader array… and community meaning human rights and so forth. (Investment expert, North-Eastern U.S.) Some investment experts see ‘socially responsible investment’ as broader than sustainability investment, because they view ‘sustainability’ as focussed mainly on the environment without too much regard to social issues. In the UK, the term ‘Social Responsible Investment’ (SRI) is normally used, rather than Sustainability Investment. SRI is more comprehensive than Sustainability Investment, in that it includes for example also attention to human rights issues. These can be important brand risks for corporations. (Investment expert, UK) For others, ‘sustainability’ clearly includes social issues. Well, sustainability is a triangle, social, environmental and economical. This is our definition. (...) It has to be economically profitable, socially compatible and environmentally compatible. ... in the long-term acceptable, the long-term issue, that originally defined sustainability, that one manages in such a way that (...) the following generations will still be able to make use of the resources, too ... this is our definition. (Investment expert, Switzerland) However, the environmental dimension might have a slightly larger weight for people using the term ‘sustainability’ rather than ‘socially responsible investment.’ Asked about how he saw the relation between socially responsible investment and sustainability investment, one of our interview partners responded: Close, very close. Social responsibility actually is the same thing for me. It is the same. It might be slightly... I think, in the Anglo-Saxon context, the ethics, social

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criteria count more, the true social criteria, although for me environment is social, too. I actually can’t separate this. I think in the European, I mean in the Germanspeaking part, the environmental sector is weighed more strongly. (Investment expert, Switzerland) One reason why the focus on social issues might be stronger in the U.S., where the term ‘socially responsible investment’ is more often used, compared to Europe where the term ‘sustainability investment’ is increasingly used, might be that this reflects main areas of concern in these regions. U.S. law and local authority law and regulations are much tighter on environmental issues than perhaps on employment conditions. So for instance, in Europe, the government tends to legislate more for maternity leave, annual leave, working week, minimum wage… And so the U.S. is better on the environment and worse on the social issues, Europe is better on social issues and perhaps a little bit worse on the environment. (Investment expert, Netherlands) However, a more important distinction between ‘socially responsible investment’ and ‘sustainability investment’ might be that sustainability has a focus on future developments. The trend in Europe to speak more and more of sustainability investment, which in some instances is also happening in the U.S. by now, might thus mirror the tendency in research to progress to longer time-scales of problems considered, explicitly including concern for future generations in the term ‘sustainability.’ One of our interview partners saw this development as a progression of issue framings from ‘ethical investing,’ via ‘environmentally responsible investing’ and ‘socially responsible investing,’ to ‘sustainability investing.’ Question: Now some people talk about sustainability or sustainable investment and some others about social responsible investment. … how do you see the differences or how do these terms relate to each other? Response:I think one is just a progression of the other. If you look at how we’ve gotten to this point. It started off… even in the 30s I think a lot of religious and charitable organizations wanted to replicate their ethos or their thinking in their investment policies… . So that was ethical investing. Then we moved forward to environmentally responsible investing … so people said, o.k. we don’t want to invest in nuclear energy for instance, or we don’t want to invest in South Africa. The next step was … described as socially responsible investing, combining the ethical and environmental issues and the social issues. And now, I think the next step from there is the sustainable element. …[I]n that case you’re actually combining the environmental and the social issues but looking forward to future generations, so it’s not just a “for now”- type of situation. (Investment expert, Netherlands) Finally, a rather unknown factor in integrating sustainability aspects into pension fund management is what the members of the funds, whose assets are actually managed, think about these issues. Some of our interview partners thought that, at least at the moment, the pension fund members are not an important force in influencing investment policy. One reason is the lack of choice that members of pension funds used to have, at least in (continental) Europe. Other investment experts, however, perceive signals of increasing interest into investment policies from pension fund memberships. [T]his is happening here in The Netherlands, we have spoken to a number of the trade unions and their workers are saying, o.k., we’re members of a trade union,

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this is what we want incorporated in our pension fund. So actually it may not even have to happen that the governments are making these calls, because people on the street are saying, o.k. there is enough damage done to the universe, let’s just… (Asset Manager, Netherlands) It will be one of the important developments to watch concerning sustainable pension fund investment, whether the membership will take a growing interest in how their pension resources are invested, and if so, whether they see sustainable asset management as an attractive option.

4.2 Different approaches and tools for taking sustainability into account 4.2.1

Standardized vs. customized products

For example with regard to selective investment, services offered to the clients can be classified either as pooled funds (standardized portfolios), or as customized products. By offering customized products, the asset manager can respond to the specific needs of the client. We actually offer customized portfolios beyond to the US$ 50,000 account level. … Most of our accounts are managed accounts, so they are individual portfolios as opposed to the pooled mutual funds. Many of our clients are single -issue focussed, maybe it is about animal rights, maybe it is about human rights, maybe it is about the environment. And so in addition to looking a the broad set of issues we then go one step lower and say “but is this right for each individual client based on their unique sensitivities?” (Investment expert, North-Eastern U.S.) While customized products are offered already for rather ‘small’ investments (compared to overall resources of institutional investors), high costs of management of such products make them efficient only for very large investments. [A] client with a fund of over 50 million Euro can have their own tailored portfolio. But a smaller client than that, we would encourage to go into a pooled fund. For them it means that the cost will be lower if we are re-balancing the portfolio. If you’ve got only 10 million Euro or something and you want to manage the portfolio actively, it can be quite expensive from a transaction’s point of view. (Investment expert, Netherlands) Like investment portfolios, information services on sustainable investment are in principle offered in customized form as well as in standardized versions. While standardized products have advantages of lower cots per user and possibly higher credibility as they may be made a little more public and transparent, increasing know-how of institutional clients concerning socially and environmentally responsible investment could lead to increasing demand of customized services as well. We also offer customized services. You know, [for our product] the investor can ask e.g., for certain filters, e.g., ... without tobacco, or without alcohol, without weapons, without etc… And there we offer as a standard ... three exclusion [criteria], but we always wrote that we can install extra filters, too. ... most buy the standard [products]. ... What we can feel now already, what will come more and

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more in the future, is special wishes, really customized, where the investor wants to focus on something special, on part of the criteria only, and for this special focus wants to make a separate screening. (Investment expert, Switzerland) Pooled funds are often close tied to an international benchmark like the MSCI World for general performance standards. Increasingly, sustainability funds offered by external asset managers use international benchmarks for peformance of stocks of ‘sustainability leaders’ (see Text Box 1 below). Especially prominent here is the ‘Dow Jones Sustainability Index,’ produced in a joint venture between Dow Jones Company and the Swiss SAM Sustainability Group. We take the leaders from the [Dow Jones Sustainability Group Index], replicate it in principle on the “big-cap”-side, and on the “small-cap”-side we still take the liberty of choosing specific pioneers, that’s about ¾ to ¼ in terms of assets, which we determine on our own. ... it’s an active management ... We have taken out certain debts already, e.g., we didn’t weigh the pharmaceutical industry as highly as the index does now, because that doesn’t fit from the sustainability point of view. So we manage this actively, ... but all leaders we have, are also in the index. (Investment expert, Switzerland)

Text Box 1: Sustainability or socially responsible stock indexes Today, a number of specialized stock indexes are available that track the share price of corporations seen as leaders in sustainability or social and environmental issues. Examples of such indexes include the Domini 400 Social Index in the U.S., the NPI Social Index of U.K. equities, and the Jantzi Social Index that screens Canadian equities.1 Another high profile example is the Dow Jones Sustainability Group Indexes (DJSGI), published by a joint venture of Dow Jones and the Swiss Sustainable Asset Management (SAM). The companies in the DJSGI are a subset of those represented in the Dow Jones Global Indexes, with the aim to include the top 10% of ‘leading sustainability companies.’ This selection is partly based on information gathered from corporations via questionnaires concerning economic, social and environmental issues. For the environment, the focus is on environmental management and reporting, with a minor consideration of environmental performance.2 According to the index providers, the companies included in the DJSGI have overall had a higher share value performance than the general universe of DJGI corporations (see Figure 1).3 This is clearly an important argument for pension funds, which have to balance sustainability considerations with fiduciary duties, to get involved in this field.

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Figure 1: Development of index values of the DJSG Index compared to benchmark indexes There are different approaches when launching a sustainability investment product. One approach is to do traditional financial analysis and sustainability analysis one after the other. Here, either the financial side can be evaluated first, and social and environmental criteria can be added afterwards; or, one can first look at companies who are sustainability leaders in their sector, and then check their financial strength. For the institutional client, the view there was, we are increasing equity exposure, but we do not want to take undue risk, so we want first the financial analysis and then the analysis taking into account the social responsibility criteria. … But for our mutual fund we said actually we want to first incorporate social and environmental criteria, and then the financial analysis. And for that fund we use a different benchmark. For the institutional clients we use just the MSCI World and for our mutual fund we use the SAM Dow Jones … sustainable index. (Investment expert, Netherlands) Another approach is to have an integrated analysis, where an interdisciplinary team, mixing financial and sustainability competence, designs investment portfolios in a rather holistic manner. I think to be successful long-term, socially aware or sustainable investment managers are going to have an integrated team. My take, when I was in Europe this summer, talking to pension funds in Switzerland, in the Netherlands and in the UK for example, was clearly that they are not looking for activist managers who have the financial team and then the social team. They are looking for investment managers who acutely understand the business and financial consequences of these other societal trends. (Investment expert, North-Eastern U.S.)

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Such an approach means that ‘mega-trends’ and their relation to value drivers are considered throughout the analysis, rather then constructing a sustainability screen that is applied before or after the financial analysis. Now, we have a universe of some fifteen hundred stocks - we run them trough preliminary analysis, we do all the traditional financial work on them. But we have started the industry level. We are not going into stock by stock and saying “goodbad, good-bad.” We say, “Where is the economy going? What are the sectors that offer the best values under these market conditions? (Investment expert, North-Eastern U.S.)

4.2.2

Selective investment vs. engagement

As discussed above in the section on different tools used by pension funds to integrated sustainability criteria into their asset management, one can distinguish a ‘selective investment approach’ from a pure ‘engagement approach.’ Selective investment can mean that strict criteria for exclusion of companies to invest in (negative screens) are implemented. However, it can also be done in an approach allowing more flexibility and giving a larger role to the judgment of the investment analyst. Our approach is, we look at the full complement and what we may do is say that this company is not as strong in human rights as we would like, but if we feel that they are moving in the right direction we would take a position with the understanding that they will be reviewed. Well, we make that now. If it is such a huge disparity that we think it puts the reputation or other things at risk - no, we would not. But we would try to really look at the big picture and think about, in this company, among our clients, what are their priorities. (Investment expert, North-Eastern U.S.) Large parts of pension resources are held in ‘indexed funds,’ where fund providers have the task to track the performance of some specific stock index without taking other active management decisions. This passive investment is viewed with concern by some people. Currently, there is a trend towards increase in passive asset management (i.e., index tracking). Today approx. one third of all assets in the stock market are passively managed. It can be expected that there is an upper limit beyond which passive management will become dangerous (if around two-thirds of the market were passively managed). Most players in investment would be followers rather than leaders then. This might imply high volatility in stock prices, if there are too few people who lead actively. (Investment expert, UK) However, index tracking also holds advantages for individual institutional clients, mainly lower costs and some form of control against the risk of misjudgments by asset managers. Within index tracking fund management, engagement is an important method for integrating sustainability criteria. Here investors seek to take part in corporate governance processes so that these criteria get attention within the companies. I know some UK investors will… because they have this passive tracker funds, they can’t sell stocks that they don’t like, so this is the only way that they can do it.

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But it’s very, very long term, it’s very difficult to assess what the impact of your action is on the company or if the company even bothers to take any notice. (Investment expert, Netherlands) One of our European interview partners, who does not yet practice pure engagement, was rather enthusiastic about this approach and its potential for the future. Yes, that’s clear, of course they have power. And if a few big pension funds formed an alliance, this could easily be equivalent to 10, 20 or 30% of the stock, and then it becomes relevant. In this case I’d ... even buy stocks in a company from which I know that they actually do rather wicked things, but then I’d go to the shareholder meetings and tell them: now you change this! This would have an enormous impact! (Investment expert, Switzerland) However, there are various degrees to which portfolio managers can actively engage with management. Especially in continental Europe, where shareholder activism is not yet as established as in the U.S., a more moderate approach to corporate governance might be expected for the near future. Not engaging as such… we will vote at annual meetings in accordance with our clients wishes, so if we see something happening and a company proposed to an annual meeting or an extraordinary meeting, that we feel it is not in the best interests of either the shareholders or the employees or… and ultimately not in the best interest of the company going forward, we will vote against it. But we won’t put petitions in front of annual meetings. (Investment expert, Netherlands)

4.3 The use of sustainability information 4.3.1

Current sources of information

At the moment, know-how on sustainability is acquired by external asset managers either by purchasing information from special Rating-Firms or Sustainability Experts, or by collecting related information themselves, for example by sending questionnaires to companies concerning their environmental policies, or by company visits. … we buy social research from various groups based in the U.S. that provide us with information on workforce, communities, human rights, environment… which is ok - it’s not great, some… it’s useful and some are specs. Then we have our own internal team and we do a couple of things: One we talk directly to companies, secondly we review our publicly available information, third we talk to thoughtleaders in the public interest arena, in government, in the academic community, to give us perspectives at a sectoral level, at an industry level and at a company level. (Investment expert, North-Eastern U.S.) In their in-house assessments of the sustainability profile of major companies, one thing providers of sustainability investment services do is to talk with the management of the companies in question.

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… [A]s part of the interfere that we would have with the company, if there are particular issues that we are concerned about, we would raise them and say, well what about your human rights record or what about your pollution conviction or now you acquired this company that has some liability overhanging, what does that mean. So, we will… it may not happen in every single case every year, but we will, as far as possible, interfere with companies also and do some research. (Investment expert, Netherlands) Some providers of sustainability investment services do all the assessment work in-house, be it questionnaires, company visits, or media content analysis. And, by the way, our whole research is primary research, so we don’t buy anything. This is an essential difference. Most of the other rating agencies or, especially, investors, they buy. Sometimes this is a wild shopping and mixing of various sources, and what we really do is 100% primary research, this means [it is] also consistent. (Investment expert, Switzerland) Others work with third parties in gaining a broader range of information than they feel capable of producing themselves. In such commissioning of research services on sustainability aspects of investment, it is important to the asset managers who outsource this work to have a good feeling on which processes are used by their information providers. Before we actually appointed the people we have appointed, we spent quite a lot of time talking to them about their process, if they simply look at the annual report, and said this is a one out of ten or a one out of five or whatever, and we were quite satisfied that it wasn’t the only thing that they did. They combined information from various environmental bodies …. Of course, there is always the risk that the information may vary from one company to another, … but that is also the case when you look at financial information that is publicly available, because some companies will interpret financial data slightly different. (Investment expert, Netherlands)

4.3.2

Quality and credibility of current sustainability information

It seems that none of the information sources currently available is really satisfying, but there are not many alternatives yet to get better sustainability information. Yes, we simply have to take something, the best that exists. ... I don’t think that it is possible to find out the sustainability leaders. I think, the leaders, those who came out there, are those who have the best investor relation department. ...Actually I personally don’t believe in this leader approach. ... The question is so complex that someone, who fills out the questionnaire well, is already in. (Investment expert, Switzerland) And I think, doing that kind of research on maybe three thousand companies to narrow your universe - you can’t be doing very intensive research - which means you are basing your research on KLD (Kinder, Lydenberg and Domini) or SAM or someone else, which is someone else’s value set which may or may not have

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anything to do with the economic drivers. So to us, it is just not a model that we would find value in. (Investment expert, North-Eastern U.S.) The general attitude money managers have concerning sustainability information is that this information should become more transparent and more specific in order to be really useful. ... but this is just their scenario. They don’t tell what they’re doing [to derive this]. Neither do they … say, in sixty years we will be completely there. They only say, this is the scenario … (Investment expert, Switzerland) In principle, standardization of sustainability information linked to the company level could help in improving transparency and comparability. The latter is important, as most large investors have global, not regional, investment strategies. It could improve in the sense that the information available on Japan and Asia and in relation to Japanese companies and Asian companies is not particularly good. And, perhaps greater standardization of information … if you look at Europe compared to the U.S. for instance … (Investment expert, Netherlands) But whether standardized or not, sustainability assessments at the company level provided by commercial investment consultants, who have only a rather limited capacity of person-power for company visits and other research methods, will by necessity stay rather superficial. With a company visit ... I don’t know. One might get a bit more out, but not a lot. ... [in case of] a huge company, one might talk to a CEO or a CFO at the head office, but then one hasn’t seen the company. I think in case of small companies it brings something, the company visit, in case of small companies, which are new, where everything is close. Rather by negative incidents, there one might get something out, so that one excludes companies really consciously. ... of course there are things, like e.g., Pfizer with full-page advertisements, which say that the Europeans are behind the times with their criticism of genetic engineering, then I do have to say, that it’s rather strange that that one should be a sustainability leader. But, I mean, this would make an exclusion list, perhaps one would reach one’s goal quicker that way. (Investment expert, Switzerland)

4.3.3

Using academic sustainability assessments in the future? Saliency and transparency

Often, informal networks of trusted contacts are much more important to investment experts than any formal sustainability assessments. These networks include academic researchers together with people from NGOs. We have a very robust network. We did not have very good contacts in the privacy arena until recently. We anticipated some of the issues, which we think - bioethics and genomics - will become increasingly important. We went out and found some people to talk to. Basically … talking to some other people we knew in public

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interest groups and said, “We are trying to build up our understanding in this area. Do you know anyone?” So we tap into that network. … we look at the agenda and we try to anticipate what are going to be the hard issues. … we take people to lunch, which is probably the most effective way. … A couple of months ago we had six lunches in a row on human rights, sweatshops, … Our job is to go and say “prevent the next situation” by saying to companies: “What is up with Turkmenistan? Who are you talking to? Have you engaged with Human Rights Watch? Have you engaged Amnesty International?” So they know that we know that this is a risk issue! (Investment expert, North-Eastern U.S.) While formal products of assessments are sometimes seen as useful, they would have to be very timely to convey new ideas to sustainability investment experts, given the high speed in the private sector. Rather than as sources for new ideas, current formal sustainability assessments are used more to crosscheck information that was gathered in informal networks. We certainly look at the academic studies that come out. And it is useful, yes. Because it helps again to confirm our signals. (Investment expert, North-Eastern U.S.) In addition to providing a fast sounding board for ideas, academic sustainability assessments could be very useful for investment experts because of the potential for interdisciplinary work that the academic world has in principle. Question: What I am interested in, there is a sustainability research at universities, too. ... Is this of any importance to you, this type of analysis...? Response: Yes, that’s important. ... what is very important in my eyes is the interdisciplinary ... at the end it’s about weighing, that’s actually the hard nut to crack. How one weighs and assesses things, isn’t it. And this is an extreme challenge. One should absolutely do this, I really think it helps. Above all that ethicists, psychologists, natural scientists, economists ... this should be a wide interdisciplinary team, which works on such criteria. This is a question that is highly dependent on the opinions of very different sides. (Investment expert, Switzerland) We got a related response from another interview partner in Switzerland, when we asked him how he would feel about a sequential approach where, for example, forest management experts would define what sustainability is in their sector, and then management scientists would take this definition and analyses corporations active in forestry accordingly. This sequential approach doesn’t work. So, that means, it really has to be a team approach, which means interdisciplinary. (Investment expert, Switzerland) In such interdisciplinary sustainability assessments, natural and social science researchers would have to interact directly with people from business schools to allow the connection of bigger sustainability issues down to the level of corporations. [W]hat we need is certainly research, which is highly ... interdisciplinary, which makes possible to proof certain hypotheses on a relatively strong aggregated level

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and … that at the end the connection between sustainability and value creation in companies, that this link is researched, too. That we find the way back to the investor, because otherwise it’s completely drifted off and makes no sense or doesn’t contribute to the search of value drivers in companies. That is, that at the end business management research has to be involved somehow. (Investment expert, Switzerland) Sustainability assessments useful for investment professionals could make use of scenario research. Well, on the one hand work on the macro level, application, scenario technique on the global level as well as perhaps on the level of current sectors. So which are ... consistent scenarios for the next ten years … in a reciprocal influencing structure of economy, society and also values, that’s important, cultural values. And one of these scenarios would have to be a sustainability scenario … that the world and the sectors develop by mainly along such lines. And then the question is, what does such a scenario contain, what are the conditions that such a scenario could come true. This is a possible sphere for research. (Investment expert, Switzerland) Scenario assessment work available today was in part perceived as being too narrow, for example as it was seen to make too little use of social science approaches. ... What’s often missing is the social science part, and maybe a little bit also the cultural part. So, the awareness, the factor culture in the development of the world, aspects of geopolitics are often taken into consideration too little. ... from the sustainability point of view one would have to reconsider the sociological point of view ... There inputs are needed. (Investment expert, Switzerland) While this interview partner clearly stressed that scenario work in sustainability assessments should not be focussed too much on technology issues, he saw information on future product innovations based on current basic research, and the possible timing of market introduction of such innovations, as important elements that should be included in useful sustainability assessments using scenario tools. … for example in the energy sector, we have just launched a new product, a new investment company. There we have to write our studies about future developments with a lot of effort. Purely technologically, I mean, when is the market breakthrough of wind energy, fuel cells, photovoltaics, and so on, and on what different conditions. I suppose … there is so much knowledge available in science concerning these things, pure energy technology under different assumptions of the social development, that the ETH would simply have to accumulate it better. [T]he knowledge probably exists, very much work is done, but then one really has to compile it to this compactness ... (Investment expert, Switzerland) Whether using scenario techniques to describe future developments, or doing research on current sustainability aspects of corporate activities via questionnaires and company visits, transparency is an important element that will decide on how this investment sector develops in the future.

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Question: Before, you have used the word transparency. Do you think that research that is available today, with questionnaires and ratings and so forth, is not transparent enough? Response:No, clearly not. But that’s clear, nobody wants to show his hand. ... Question: I think, there is a trade-off, I mean, people want to sell this, too. If you have customers as a bank, a big pension fund for example, churches, you said, big investors, they, too have to get convinced of this being good. A certain transparency there is necessary. Response:Well o.k., towards the customers it might be something else, that’s true, there we are open. ... But still one has to be careful, I mean the fear of losing this know-how is really big. (Investment expert, Switzerland) Academic sustainability assessments could play an important role in helping to establish larger transparency in this field. If such transparency were to be achieved, sustainability investment has the chance to enjoy very high growth in the years to come. I think in seven years time, we won’t be talking about sustainable investing because everybody will just be doing it. And companies will be valued more highly for that reason as well as because they perform well financially. And at that point you may be looking at a new class of products, which is more your sustainable company, your pioneer company, your alternative energy or maybe you’re looking a little bit at quality of life issues. That is my own view, I mean it’s a personal view but I really feel that this is actually how it will evolve. … I mean the time scale may be a little bit longer or a little bit shorter, I don’t know. Of course if there is a major bear-market in the meantime then people may just become very safety-conscious and pull back from equity a little bit, so that may influence things a little. I don’t expect that to happen but it’s my view that socially responsible investing will become very mainstream. (Investment expert, Netherlands)

5 SUMMARY AND CONCLUSIONS Financial investors are important actors in the sustainability context, as they manage the transition from economic successes of the past (expressed in savings) to those of the future (by investing these savings in new technologies and activities). Among investors, especially pension fund investors should be interested in the impacts of sustainability issues on long-term investments because they have liabilities for a number of decades ahead, as employees paying contributions today expect pension benefits when they retire. While pension fund managers also have responsibility for the short- to mid-term, this intrinsic long-term nature of pension investment makes pension fund managers rather sensitive to the need of maintaining a livable environment (both natural and social) far into the future. Indeed, sustainability issues are already taken into account by many pension fund managers. One reason for this is that spectacular environmental disasters like the Exxon-Valdez oil spill have had grave consequences for pension funds, which are major shareholders in companies involved in such disasters. But sustainability concerns of pension fund managers go beyond the environmental domain. Social issues

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like workplace discrimination based for example on race or sexual orientation are of equal concern for many pension funds as shareholders, and are often considered in an integrated manner together with environmental concerns in ‘socially responsible’ or sustainable pension fund investment. These concerns are today usually framed in purely economic terms, in line with the mandate to maximize value for the funds’ members. Urging companies they hold stock in to prevent environmental disasters, or to stay clear of workplace problems, avoids dangers to profits and growth for pension funds. If the ‘first revolution’ in pension fund investment described by Peter Drucker gave employees control, albeit indirectly, of most large companies, the emerging activities of pension funds in sustainability investment have the potential to cause another radical shift in financial markets, with large implications for a sustainable future. This development has just begun to be registered in the financial industry as a relevant trend, while as yet there are not many discussions within the sustainability science community about this development, and about this community’s potential contributions to it. As discussed, pension funds become active in sustainable asset management either through selective investment or pure engagement approaches. And external consultants support these funds with standardized or customized sustainability investment services. Figure 2 below presents different combinations of these strategies, together with the information sources on which they are based. As illustrated in this figure, in principle eight basic types of actions concerning sustainable asset management could be expected to occur. Our study has found that the four action types in the upper layer of the figure, where the sustainability information is derived from purely commercial sources, are all currently exerted by different combintations of players in this field. The four types in the lower layer, however, show little activity at present. Changes in design and communication of academic sustainability assessment research would be necessary in order to make these areas of the ‘Sustainable Investment Cube’ accessible to actors in the investment community. Such an increasing role of academic sustainability science in the sustainable asset management field would improve the quality of the information available in this domain. Even more important would be its impact on increased transparency of sustainability information available here.

Figure 2: The ‘Sustainable Investment Cube’ concerning strategies of the different actors 41

The limited utilization of sustainability science may be sufficient at the present “niche market” stage of sustainability investment. However, a continued lack of involvement could seriously impede its significant potential for growth. In the early stages of sustainability investment, verifying the presence of an environmental management structure or a formal sustainability strategy may have been sufficient to judge whether a company was a sustainability leader or laggard. As similar instruments become part of the corporate mainstream, sustainability investors will have to progress to assessing the actual content of such corporate efforts towards sustainability, rather than their purely organizational aspects, which may be mere window dressing. This increased level of scrutiny will not be possible without more support from the sustainability science community. As one step in this direction, a group of researchers and consultants are currently starting a program to provide the sustainability investment community with knowledge from sustainability science in the form of ‘Sustainability Business Cases’ that are easily accessible and directly relevant to investors.4 If more such bridges between sustainability investment and sustainability science are built, there is a real chance that sustainability investment may become very mainstream in pension fund investment, with large potential benefits for sustainable development worldwide.

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6 REFERENCES Annan, Kofi A. 2000. “Sustaining the Earth in the New Millenium: The UN Secretary-General Speaks Out.” Environment 42:20-30. Beck, Ulrich. 1994. “The Reinvention of Politics: Towards a Theory of Reflexive Modernization.” Pp. 155 in Reflexive Modernization. Politics, Tradition and Aesthetics in the Modern Social Order, edited by Ulrich Beck, Anthony Giddens, and Scott Lash. Cambridge, UK: Polity Press. Cannell, Charles F., and Robert L. Kahn. 1968. “Interviewing.” In The Handbook of Social Psychology, edited by Gardner Lindzey and Elliot Aronson. Reading (MA): Addison-Wesley. Clark, William C. 2001. “America’s National Interests in Promoting a Transition to Sustainability.” Environment 43:18-27. Converse, Jean M. 1987. Survey Research in the United States. Roots and Emergence 1890-1960. Los Angeles: University of California Press. Denzin, Norman K., and Yvonna S. Lincoln. 1994. Handbook of Qualitative Research. Thousand Oaks: Sage. Drucker, Peter F. 1976. The Unseen Revolution. How Pension Fund Socialism Came to Ameria. London: Heinemann. Fukuyama, Francis. 1999. The Great Disruption: Human Nature and the Reconstitution of Social Order. New York: Free Press. Kohler Riessmann, C. 1993. Narrative Analysis - Qualitative Research Methods Series 30. London: Sage. Levy, David L., and P. Newell. 2000. “Oceans Apart? Business Reponses to Global Environmental Issues in Europe and the United States.” Environment 42:8-20. Mishler, E. G. 1986. “The Analysis of Interview-Narratives.” In Narrative Psychology - The Storied Nature of Human Conduct, edited by T.R. Sarbin. New York: Praeger. National Research Council, Board on Sustainable Development, Policy Division (Ed.). 1999. Our Common Journey: A Transition Toward Sustainability. Washinton D.C.: National Academic Press. Roddick, Anita. 2000. “Foreword.” Pp. 8-9 in Terms for Endearment - Business, NGOs and Sustainable Development, edited by Jem Bendell. Sheffield: Greenleaf Publishing.

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7 ENDNOTES 1

See www.domini.com, www.npi.co.uk, and www.mjra-jsi.com.

2

While parts of this questionnaire which are specific for the various industry sector are proprietary knowledge of the index providers, the general part of the questionnaire is publicly accessible at www.sam-group.ch/d/PDF/LR_Questionnaire_E.pdf. 3

It should be noted that the DJSGI was introduced in September 1999, and that index values reported for earlier periods represent backtracking of how the mix of corporations included at that date were valued on the stock market in the time before. That leaves open how the index would actually have been composed at these earlier times, given the information available then. Backtracking thus has to be taken with at least a grain of salt. For more information on the DJSGI see indexes.dowjones.com/djsgi. 4

For more information, please contact the author at [email protected].

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