The ‘Slippery Slope’ of ESG Demands?

Julie Segal of Institutional Investor reports, The ‘Slippery Slope’ of ESG Demands:
State Street Global Advisors, PGIM, and other managers are making environmental, social, and governance (ESG) criteria part of their overall investment processes, but the head of Ontario Teachers' Pension Plan reminded an audience Tuesday that the real goal remains being able to pay pensions.

"We're investing if we can get the return we need, whether in electric utilities, battery technology, micro grids," said Ontario Teachers' CEO and interim chief investment officer Ron Mock, speaking on a panel at the Milken Institute's 2018 Global Conference. "All of this is critically important, not just because it's a feel-good. But these are new opportunities going forward and we want to be there."

Mock emphasized that Ontario Teachers' is a fiduciary obligated to pay pensions. "We have to earn a return."

Mock explained that the social piece of ESG is the toughest challenge for the Canadian pension plan, which manages C$190 billion ($148 billion) for hundreds of thousands of teachers. These educators "want to make things better," he said. "Think about Florida and guns in the classroom, automatic weapons in the classrooms. If you think we haven't heard from our teachers about the companies we invest in, you'd be sadly mistaken."

But some controversial asset areas — such as fossil fuels — Mock saw as a "slippery slope." If the plan, for instance, pulled its money from fossil fuel companies, other activists could call from divesting from the banks that serviced these businesses.

Ontario Teachers' approach resonated with MetLife CIO Steven Goulart, who compared it to MetLife's investment strategy for its massive general account. "We're not doing our job if we're not taking into account all risk factors," Goulart said. "Before we invest in any corporate bond, we ask what are the governance issues that will impact this?" Comprehensive analysis, in his view, is "all part of our job." But in another part of his job — president of MetLife's institutional asset management business — Goulart has customers pushing for ESG principles. The category is exploding, according to Goulart.

Ronald O'Hanley, president and chief operating officer of State Street Corp., likewise saw ESG criteria is critical to determining what risks a company is facing in the years ahead. "If you think about the pension liabilities that Ron [Mock] has to meet, they're very long term," said O'Hanley. ESG has evolved from screening out certain companies such as those in tobacco or alcohol, to including businesses that are working on sustainable or other products, he noted. "When we first started talking about ESG, it was 'thou shalt not.' Then we moved to 'Thou Shalt' buy clean energy."

Street Global Advisors — which has major passive and active management businesses — has become a high-profile advocate for more women in senior management and on boards, even for companies in its index funds. As a passive investor, it has to own every company in the indexes its products track. "We don't have the freedom to walk away in passive. I can't turn the S&P 500 into the S&P 499," O'Hanley said.
The slippery slope of ESG demands is the topic du jour. Everyone is focused on environmental, social and governance factors and large pensions take this very seriously as it's part of their commitment to responsible investing.

For example, check out what some of Canada's large pensions state on responsible investing:
Things have changed a lot from my time working at large pensions. Nowadays, they actually take this stuff seriously and so do many other institutional investors.

These days, both institutional and retail investors stay abreast on ESG investing trends and there is a proliferation of products out there catering to everyone's specific needs.

In fact, the Financial Times recently reported that a business led by Rob Arnott, the entrepreneur known as the “godfather of smart beta”, is tapping into demand for investment products that address concerns over environment, social and governance issues.

I have covered ESG investing on this blog in a few comments:
I must admit, every time I hear the word "divest", I still cringe. Why? Because it might make you feel good to divest from tobacco, firearms and other investments you deem a social menace but divesting comes at a cost and while some members of a pension fund want to divest, others don't because their focus is on achieving a required return to maintain an adequate funded status of their pension over the long run.

I recognize everyone has an environmental and social cause and some people feel passionate about it. I once had a lady question me about enjoying a New York Striploin steak at Baton Rouge restaurant. "How can you say you love animals and the environment and eat meat?".

I told her: "Very easily, all I do is ask them to add steak spice and cook it medium rare, tastes absolutely delicious."

Some of these environmental zealots are very direct and they look at you like you're the devil if you eat meat. I don't bother them for eating a plant-based diet, why do they feel they have a right to tell me what I can and can't eat?

If you want to eat tofu and seaweed, be my guest, once every couple of months, I like eating a juicy steak and I enjoy it. I have zero regrets, just like I have zero regrets about gorging on a Harvey's Angus burger once in a while when I have the munchies for a late night snack.

Do I eat red meat every day? Of course not. Do I ask my pension fund to divest from McDonald's and other fast food restaurant stocks? Of course not.

While I think there are merits behind some divestments (tobacco), I seriously question others (pipelines) and think the debates lack something crucial: scientific facts.

It's a fact that tobacco is highly addictive and is responsible for millions of deaths around the world. It's also a fact that pipelines are environmentally safer than other modes of transportation so why are people so bloody foolish when it comes to expanding pipelines in Canada?

It comes down to religion. Some people believe they are saving the environment by eating plant-based diets and torpedoing pipeline deals, while others are more careful and balanced in their assessment.

Now, before I start receiving hate emails from environmental zealots, it's also worth noting that I have nothing against ESG investing as long as pensions generate sufficient returns to pay out their long-dated liabilities.

If you want to invest in solar, wind farms, electric utilities, avocado ranches, that's all great but make sure your focus remains 100% on achieving your actuarial return over the long run or else I'm not impressed.

Can you make money in ESG investing? Absolutely. In fact, some studies have argued that responsible investing leads to better returns over the long run and many people feel sustainable investing is an opportunity to make money and make a real difference in the world.

I'm all for a) making money and b) living in a better world but my focus is first and foremost on achieving the return because, without money, you won't be changing the world for the better.

There are however some big trends going on which will impact industries over the long-term. The Caisse is aiming to cut portfolio's carbon footprint 25% by 2025. Other large pensions have similar lofty goals.

Slowly but surely, the world is changing and 100 years from now, alternative energy sources are going to be equally, if not more important to the overall economy than traditional oil & gas which is why large pensions and other institutional investors need to adapt and invest in this area or they risk being left behind.

The Saudis need to diversify their economy. Same thing with Norway, Russia, Mexico and others who generate huge revenues from oil & gas. They simply have no choice (Norway is way ahead of everyone in this regard).

But while ESG investing is changing the investment landscape, pensions have a fiduciary duty to their members to deliver the required actuarial return and that's what Ron Mock is alluding to when he was discussing the 'slippery slope' of ESG demands.

Below, Ron Mock, Ontario Teachers' Pension CEO, speaks to CNBC's David Faber about the organization's investing strategies. Great discussion, listen to his wise insights.

And James Kynge, the FT's EM editor, explains how investments in ethical companies have outperformed standard EM indices. As a result, large institutional investors like Swiss Re are switching their investment portfolio towards ESG indices.

Lastly, I want to mention that Ontario Teachers' Pension Plan just announced the appointment of Dale Burgess to the position of Senior Managing Director, Infrastructure & Natural Resources (INR), effective immediately.

You can read the press release here. I want to congragulate Dale publicly and have heard nothing but good things about him from his former boss and predecessor, Andrew Claerhout. I'm glad Teachers' filled this position internally.