The Canadian Source Of Employee Pension Fund Investment And Benefits Plan Management

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UN Links Environment To Performance

By: Ian Ihnatowycz & Martin Grosskopf

There is increasing evidence to suggest that environmental and social factors can have a material impact on security valuation levels and, by inference, on investment performance. A recent study conducted by a group of asset managers, under the auspices of the United Nations1, shows a clear link between these complex issues and equity valuations within a number of sectors.

For Canadian institutional investors, the results provide clear evidence of the need to apply the same level of diligence on material social and environmental factors as to other financial concerns within their analysis and portfolio management processes.

In early 2003, the United Nations Financial Initiative formed an asset management working group (AMWG) tasked with determining whether there was adequate evidence to suggest a link between social and environmental factors and equity valuations. Acuity Investment Management and 11 others managers from North America, Europe, Asia, Africa, and Latin America with considerable experience in managing portfolios using environmental and social criteria were asked to develop a work plan to address this issue.

Base-line Research

The AMWG focused its efforts on providing base-line research on the merits of applying environmental and social criteria within the investment decision process. The research was to be completely divorced from any ethical imperative. To accomplish this, the AMWG contacted 50 sell-side research firms who employed leading analysts within a number of target sectors which faced particularly challenging social issues. The response was strong, with 11 reports from nine brokerage houses, representing most regions in the world with the exception of North America. The sectors covered included oil and gas, chemicals, apparel, electronics, insurance, utilities, and aviation.

The results found that:

The Canadian Context

Given the tendency in Canada for environmental and social issues to be framed in an ethical or political context, it is not surprising that there has been relatively little emphasis on these issues within the pension community. Indeed, when faced with stakeholder pressure to apply ethical screens to plan investment portfolios, most trustees are advised by their legal counsel and/or consultants to avoid applying any non-financial criteria that would limit the investable universe, given that their primary responsibilities are to preserve capital or maximize returns within acceptable risk/return parametres. Unlike in the European or U.S. context where some high profile pension plans – such as ABP (Netherlands), CalPERs (California), and the City of New York – have interpreted fiduciary responsibility to include consideration of social objectives, very few Canadian pension investors have adopted this approach. Those that have tend to be mission based investors with very definable social objectives.

Most pension plans would generally agree that their investment managers should take social and environmental issues into consideration where they may have a material financial impact. However, unlike governance issues that are examined proactively and explicitly, environmental and social factors are generally only considered after the issues have already had a material impact. This tendency to be reactive is evident from a number of sources:

There are some exceptions where analysts have addressed both short- and long-term environmental impacts. A recent Lehman Brothers report on the Power and Utilities sector, although focused on U.S. utilities, found a significant deficiency within most companies in the sector in reporting capital expenditure requirements for pending air emissions legislation4. Unfortunately, this in-depth analysis is rare and continues to be issue specific, largely ignoring the financial impacts of other regulatory initiatives on waste disposal or water use, for instance. Clearly, client interest and requests will serve to increase the resources devoted to these issues and improve the quality of analysis within sell-side brokerages and independent research firms.

Path Forward

The work of the AMWG provides clear evidence that incorporation of social and environmental criteria within a variety of valuation methodologies is both possible and prudent within a fiduciary context. While a sophisticated approach on these issues begins with tasking investment managers with developing and applying appropriate sector specific criteria5, other areas that institutional investors should consider include:

The AMWG research is ground breaking in being the first global attempt to evaluate social and environmental issues systematically within the context of fundamental security selection. The results indicate that the issues have material impact on equity valuation levels and, by inference, on investment performance. Furthermore, their inclusion is not dependent on adoption of an explicitly ‘ethical’ investment policy. As a result, institutional investors should ensure that their investment decision-making and portfolio management process incorporates an appropriate emphasis on these increasingly important issues.


Martin Grosskopf is investment analyst and manager of sustainability research and Ian Ihnatowycz is president and chief investment officer at Acuity Investment Management.

1. UNEP Finance Initiative, The Materiality of Social, Environmental and Corporate Governance Issues to Equity Pricing, June 2004.

2. Dresdner Kleinwort Wasserstein, European Utilities: Carbon Derby, October 2003.

3. Robert Repetto, Silence is Golden, Leaden, and Copper. Disclosure of Material Environmental Information in the Hard Rock Mining Industry, Yale University, July 2004.

4. Lehman Brothers, On the Regulatory Horizon, Dark Clouds with a Silver Lining, September 2004.

5. Please refer to Goldman Sachs report noted above for a general introduction to environmental, social and governance criteria.

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